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Published by: richardck30 on Jul 25, 2010
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Continental Capital Advisors, LLC July 23, 2010
Worrying Signs From The Federal Reserve Minutes
Last week, the Federal Reserve released the minutes of its Open Market Committee meeting thatconcluded on June 23.
Meeting participants were hopeful that the economic rebound wouldcontinue, yet a number of statements from the minutes highlight the slowdown in the US economy.Additionally, the Fed minutes note an increase in “fails to deliver” securities, which could signal thatthe limit of quantitative easing already has been reached because of a lack of liquid securities.The following excerpts from the minutes of the Federal Reserve’s Open Market Committee meetingdemonstrate that Federal Reserve members are aware of a slowdown in the economy:Economic data releases were mixed, on balance, over the intermeeting period, but marketparticipants were especially attentive to incoming information on the labor market--mostnotably, the private payroll figures in the employment report for May, which wereconsiderably weaker than investors expected. Those data, combined with heightenedconcerns about the global economic outlook stemming in part from Europe's sovereign debtproblems, contributed to a downward revision in the expected path of policy implied bymoney market futures rates.…While the recent data on production and spending were broadly in line with the staff'sexpectations, the pace of the expansion over the next year and a half was expected to besomewhat slower than previously predicted.…The implications of these less-favorable factors for U.S. economic activity appeared likelyto be only partly offset by lower interest rates on Treasury securities, other highly ratedsecurities, and mortgages, as well as by a lower price for crude oil. The staff still expectedthat the pace of economic activity through 2011 would be sufficient to reduce the existingmargins of economic slack, although the anticipated decline in the unemployment rate wassomewhat slower than in the previous projection.…In part as a result of the change in financial conditions, most participants revised downslightly their outlook for economic growth, and about one-half of the participants judged thebalance of risks to growth as having moved to the downside.…Indeed, data for the most recent month suggested that, with the expiration of thoseprovisions, home sales and starts had stepped down noticeably and could remain weak in thenear term; with lower demand and a continuing supply of foreclosed houses coming tomarket, participants judged that house prices were likely to remain flat or decline somewhatfurther in the near term.…The economic outlook had softened somewhat and a number of members saw the risks tothe outlook as having shifted to the downside. Nonetheless, all saw the economic expansion
Continental Capital Advisors, LLC July 23, 2010
as likely to be strong enough to continue raising resource utilization, albeit more slowly thanthey had previously anticipated.…In sum, the changes to the outlook were viewed as relatively modest and as not warrantingpolicy accommodation beyond that already in place. However, members noted that inaddition to continuing to develop and test instruments to exit from the period of unusuallyaccommodative monetary policy, the Committee would need to consider whether furtherpolicy stimulus might become appropriate if the outlook were to worsen appreciably. Giventhe slightly softer cast of recent data and the shift to less accommodative financial conditions,members agreed that some changes to the statement's characterization of the economic andfinancial situation were necessary.…About one-half of the participants saw the risks to their growth outlook as tilted to thedownside; in contrast, in April a large majority of participants saw the risks to growth asbalanced.In the past, statements acknowledging an economic slowdown would have prepared marketparticipants for the possibility of interest rate cuts. Economists would have projected interest ratecuts into their forecasts and highlighted the benefits of lower rates for the stock market and theeconomy. However, with the federal funds rate currently at 0%, interest rate cuts cannot be a part of the arsenal used to combat an economic slowdown.Few market commentators are discussing how the inability to cut interest rates will increase thelikelihood and the severity of a downturn. This is surprising because there have been recessionseven when the Fed could lower interest rates. In contrast, complacency exists because it is widelyaccepted that the Federal Reserve has other tools to support the economy and stock market.However, additional action by the Federal Reserve would signal its failure to revive the economy.Therefore, we believe that the Fed is unlikely to use a “nuclear option” until there is a stock or creditmarket panic.Regardless of the timing of further Fed policy action, it is unlikely that additional quantitative easingwill lead to more than just a temporary bounce in asset markets. For one, Japan’s historydemonstrates that continuous quantitative easing does not necessarily lead to sustained economicgrowth or to higher stock prices. Additionally, a further decline in long-term interest rates onmortgages and government bonds is unlikely to be as stimulative as in the past since rates arealready so low. Finally, the following statement from the minutes of the Federal Reserve’s OpenMarket Committee meeting could mean that quantitative easing has reached its practical limit:In his presentation to the Committee, the Manager noted that ‘fails to deliver’ in themortgage-backed securities (MBS) market had reached very high levels in recent months.Under these conditions, dealers had experienced difficulty in arranging delivery of a smallamount--including about $9 billion of securities with 5.5 percent coupons issued by Fannie

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