Fed having to fight on two fronts

October 31, 2013 10:59 PM
Blog first appeared in DanCollinsReport on Nov. 1, 2013

Over the past year I have written many of the "Markets" features for Futures Magazine, which focuses on one particular market sector. The one constant fundamental factor mentioned by market analysts I interviewed; whether discussing interest rates, equities energies or metals for that matter, was the Federal Reserve’s plan to taper the asset purchases that are part of QE3.

Equity and Treasury markets reacted violently to the May suggestion by Federal Reserve Board Chairman Ben Bernanke that the Fed would begin tapering its assets purchases before the end of the year. He later clarified his statement leading many analysts to believe tapering would begin at the September FOMC meeting. That did not happen but it had already become clear that based on the recent economic numbers the Fed would hold off.

Recently I suggested that the battle over the debt limit — the second time in three years it had gone down to the wire and caused some reaction by financial players — damaged demand for Treasuries, and created another fundamental factor the Fed would have to consider in its analysis.

I was curious to see if there was anything in the FOMC statement from its October meeting that would address what impact that debate had on their deliberations.

It is always tricky reading Fed tea leaves.

The statements from the October and September meeting did add one item that could be seen as the Fed taking a shot at Congress. In September it stated “Taking into account the extent of federal fiscal retrenchment, the Committee sees the improvement in economic activity and labor market conditions since it began its asset purchase program a year ago as consistent with growing underlying strength in the broader economy.”

In October it added,” Taking into account the extent of federal fiscal retrenchment over the past year.” Apparently they wanted to make clear to some people that they were referring to the sequestration.

The statement following the prior two meetings did not use the phrase: “Taking into account the extent of federal fiscal retrenchment,” but did state, “Fiscal policy is restraining economic growth.”

In essence the Fed is saying to Congress, ‘We want the same thing as you. We want to withdraw the extraordinary stimulus in our policy but you have to work with us.’

Andrew Wilkinson commented to me in an interview several months ago that this was the first time in memory where U.S. fiscal policy was working at odds with Fed policy.

The notation, “Taking into account the extent of federal fiscal retrenchment,” may seem relatively mild but it is pretty bold in Fedspeak. The odd thing is that the same folks critical of the Fed’s ongoing accommodations have pushed the sequestration cuts which the Fed apparently believes are handcuffing them to some extent.

Will these same folks make nice in February before the debt ceiling must be extended again or will they throw another roadblock in front of the Fed? No one knows the answer but it may be time for Ben Bernanke and the Federal Reserve to stop being so subtle and explain how fiscal policy and budgetary dysfunction are affecting their ability to begin the long unwinding process.


About the Author

Editor-in-Chief of Modern Trader, Daniel Collins is a 25-year veteran of the futures industry having worked on the trading floors of both the Chicago Board of Trade and Chicago Mercantile Exchange.