Fed's words might not say as much as their actions

By DAVID MOON, Moon Capital Management, LLC
March 18, 2012

Based on the statement released by the Federal Reserve Board’s Federal Open Market Committee (FOMC) following its March meeting this past week, one wonders why they even bothered with the meeting. The statement was almost a carbon copy of the one released following the last FOMC meeting in January.

Observations about economic factors such as household spending, employment, inflation, global financial markets and oil prices were not only similar from two months ago, in many sections of the brief five-paragraph release, the wording was almost verbatim.

In a repeat of January, the committee also decided to continue its program of moving money from short-term securities into longer-term bonds, in an effort to keep downward pressure on longer-term interest rates.

And just like in January, Jeffrey M. Lacker, the President of the Federal Reserve Bank of Richmond, was the sole member who dissented from this decision.

The press release from the meeting doesn’t tell us much – at least not much that we didn’t know two months ago. But we can discern some things by what the group didn’t say and by what they do.

Their words indicate almost no concern about inflation. This is pretty consistent with their actions. The only area of potential inflationary pressure mentioned by the Fed is energy, due to rising oil prices.

It’s ironically disingenuous that the Fed would offer the obvious warning that Middle East instability might lead to higher oil prices, while expressing no concern about the inflationary impact of pumping two trillion dollars into the US economy in less than two years, without a corresponding increase in GDP.

A skeptic might wonder if this nod to higher oil prices is a handy way to deflect future criticism for the Fed’s own actions when the official rate of inflation catches up with real price increases at the grocery store.

The markets are obviously skeptical about the Fed’s repeated statement about holding interest rates to near zero until the end of 2014. As the meeting minutes were released, prices on the fed-funds futures market began to suggest that traders expect the Fed to begin explicitly increasing interest rates by early 2014. Rates on 30-year Treasuries also increased, even as the Fed publicly restated its commitment to keep those rates low for another 21 months.

Businesses and investment banks don’t seem to expect the low interest rate environment to last forever, either. Both seem in a rush to take advantage of the current situation. Last week, there were $58 billion of new corporate bonds issued, the most in a single week in almost two years.

Investment banks and corporations realize that investors are chasing yields, and lowering quality requirements to do so. The investment banks and borrowers are happy to oblige the yield-hungry investors.

It’s nice that the Fed releases this statement after each meeting, but it might be more useful if they bothered to change the text from meeting-to-meeting. Until then, investors will have to continue trying to interpret their actions, not their words.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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