Published by WallStreetWeather.net
The Federal Reserve announced September 21 it will sell a total of $400 billion in Treasuries with maturities 3 years or less to buy an equal amount of Treasuries maturing in 6-30 years by the end of June 2012. In the FAQ accompanying the FOMC statement, the Fed believes:
“The reduction in longer-term interest rates, in turn, will contribute to a broad easing in financial market conditions that will provide additional stimulus to support the economic recovery.”
Yet the FAQ admits that:
“The maturity extension program will provide additional stimulus to support the economic recovery but the effect is difficult to estimate precisely."
If the Fed is unsure how flattening the yield curve will affect the economy, then why did most members of the FOMC Committee except for regional bank presidents Richard Fisher (Dallas), Narayana Kocherlakota (Minneapolis), and Charles Plosser (Philadelphia) vote to act?
The answer can be found in the FOMC statement:
“Moreover, there are significant downside risks to the economic outlook, including strains in global financial markets.” [bold emphasis mine]
The Fed announced at its August 9 meeting that it would likely keep the zero to 0.25% fed funds target range “at least through mid-2013” as “downside risks to the economic outlook have increased.” Six weeks later the Fed is saying those downside risks have become “significant.”
“Global financial markets” indicates the Fed is concerned about a global economic slowdown impacting the U.S. economy coming on top of the impact of the European sovereign debt crisis on the financial system as I described in “Lehman’s Harvest Moon Returns to Haunt the U.S. Through the Eurozone.”
The Fed’s Maturity Extension Program would have to generate enough borrowing by consumers to spur economic growth to offset the damage it will cause to the banking system. The problem with the Fed’s logic is that there are three crucial elements that must be in place to spur consumer lending:
1. Economic conditions would have to at least stabilize and show signs of growth.
2. Banks net interest margin (NIM) would have to cover their cost of funding.
3. The risk weighted cost of capital would have to be stable to declining.
All of these conditions have not been met, and Wednesday’s Fed action will end up inflicting further damage to the financial system which will in turn cause additional economic contraction.
The Fed assumes that by reducing the interest rate on long term Treasury yields, it will in turn pull down the entire credit curve. While this would be true in good economic times, the margin between less riskier and riskier credits becomes significantly wider during challenging economic times which the Fed has clearly indicated the economy is currently experiencing. Therefore it becomes less likely borrowers with riskier credit will be able to cover their interest payments, likely causing leveraged companies to go into bankruptcy.
As the Fed flattens the yield curve, banks will continue to shrink their balance sheets rather than make unprofitable loans since expanding their loan portfolio requires banks to accumulate more capital to back up the loans. This is not feasible with bank stocks trading not far from their Great Recession lows.
Even if banks pay zero interest on deposits, fees for FDIC insurance, the cost of processing transactions, and operating their branches raise the cost of funds above zero. So as the Fed pushes intermediate and long term interest rates down, the NIM shrinks because banks can no longer reduce their cost of funds relative to revenues.
For example, if short term interest rates were 3% and long term interest rates were 6%, the Fed could lower each 0.25% and still leave the NIM stable. But with short term interest rates at zero, each notch lower in longer term interest rates directly shrinks NIM.
Monetary policy is forcing banks to switch from traditional lending to fee-based operations. On the consumer side, banks will look at consumer lending that “earns its cost of capital” in terms of both interest rate margin and fees. The focus will be increasingly on credit cards with high interest rates versus traditional lending such as home equity and auto loans. Banks will put even more emphasis on the risk weighting of particular loans as they move away from consumer to commercial lending.
Banks will shrink their balance sheets, avoiding businesses whose earnings are not far greater than the risk weighted cost of capital. Fed policy has not only evaporated the ability of consumers to earn interest income on their savings, but is resulting in consumers receiving less and paying significantly more for retail banking services. Already banks are charging fees to consumers with small balances in their savings accounts.
Fed policy will cause significantly more Americans to become “unbanked” as they are pushed out of the banking system. This has dangerous economic and societal implications as more consumers turn to Wal-Mart, check cashing stores, and other alternatives charging outrageous fees. Crime rates are likely to increase as more consumers keep their cash at home to avoid fees. Avoiding fees with banks offering free online bank accounts does not help the poor who cannot afford to pay for a computer or smartphone with a secure internet connection and security software.
The type of lending Fed policy is promoting is not the type of lending that promotes economic growth and employment. The companies able to line up financing are using it to acquire other companies. The end result is higher prices and increased unemployment. While the fat M&A fees have been a bright spot for banks, banks don’t want to hold any loans associated with the transactions.
The negative effects of monetary policy extend beyond banks and insurance companies. The Fed continuously cites their dual mandate imposed by Congress “to foster maximum employment and price stability.” Yet Fed policy could end up significantly reducing employment in both the public and private sectors.
Last month’s employment report showed positive gains in private employment but was offset with more reductions in government employment. For monetary policy to work, these employment losses would have to be offset by increased consumer and business borrowing to significantly spur enough economic growth to accelerate private employment.
Lowering long term interest rates even further will significantly raise the amount of pension contributions for state and local governments along with the federal government. Government employment will decline in order to pay for pensions.
When a company or municipal government has to contribute more to its pension plan, it will have to recover the cost through reductions in employment. Companies with traditional pension plans will also be affected as they are forced to divert cash to fund pensions instead of using the money to purchase equipment and hire more workers. Obviously this has a cascading effect throughout the economy as companies and governments that must contribute more to their pension plans have less available cash to buy new servers from Cisco or new computers from Dell.
Although long term Treasury yields have been declining as institutional investors seek to make a capital gain selling to the Fed, fears of a worldwide economic slowdown have spurred a flight to safety to U.S. debt. Viewed from a “free market” perspective, the Fed’s gloomy outlook already lowered yields to record low levels, so the marketplace has already done the Fed’s job for them! The market has become so fearful that they’re even willing to pay the U.S. Treasury to take their money as three month Treasury Bills have frequently turned negative.
Fed Chairman Bernanke has said numerous times that one of the remaining “policy tools” the Fed can employ to encourage banks to make more loans would be to lower the 0.25% interest it pays on the excess reserves banks are keeping at the Fed. Without raising Treasury interest rates this would further stress banks, causing them to increase fees to consumers or reject small deposits entirely. Banks may not have the capital to transition excess reserves into loans that bear a higher risk weighting than Treasuries.
“Whenever the energies of Uranus are pronounced, the market is not going to behave the way you expect it to.” – Weekly Forecast, September 19-26
After moving between positive to choppy and mixed conditions Wednesday, the major indices reversed to negative immediately after the FOMC statement was released. The stock market expected the Fed to do the Twist which didn’t work in 1961 and won’t work now. But with Saturn in Libra squaring the Fed’s natal Mars and Ascendant in Cancer, the Fed felt pressured to act. With Cancer’s ruler the Moon in Scorpio in the sector of the Fed’s chart ruling speculation, the Fed probably feared the market would decline without additional policy accommodation.
The Sun opposing Uranus created the exact opposite effect: Instead of pouring into stocks, investors dumped stocks and commodities. The Moon in Cancer reflected investors sought shelter in safe haven U.S. Treasuries.
The Sun represents leaders and its opposition to Uranus represents opposing forces. The same three members who dissented at the August 9 meeting dissented again. External opposition came in the form of a letter to Chairman Bernanke from House Speaker Boehner, House Majority Leader Eric Cantor, Senate Minority Leader Mitch McConnell, and Sen. Jon Kyl requesting the Fed “resist further extraordinary intervention in the U.S. economy.”
“Expect the unexpected” succinctly sums up the energies of Uranus. Or to borrow a phrase from Fed Chairman Bernanke, Uranus represents conditions and situations that are “unusually uncertain.” Bernanke should know with his progressed Sun and Venus (monetary policy) in Uranus-ruled Aquarius.
Uranus represents extremes and as its squares Pluto, those extremes become wildly accentuated. Pluto represents massive wealth as well as bankruptcy as Pluto rules debt. Pluto’s energies are strong now, having just turned direct September 16. When these two planets form a seven part series of exact squares during 2012-2015, their energies can bring shockwaves, chaos, and massive upheavals as conditions go too far in one extreme. The purpose of this process is to release what has become outmoded and corrupted so that transformation can occur.
Reflecting the energies of Uranus and Pluto which have been impacting the Fed’s natal Sun, Pluto and the sector of its chart representing its reputation (Midheaven), the Fed did initiate a policy reversal Wednesday by once again reinvesting principal payments of its holdings in agency debt and agency mortgage-backed securities in agency MBS. (Originially announced at the August 10, 2010 meeting, the program ended when the Fed began reinvesting agency principal payments in Treasuries.)
Besides impacting the U.S. and Europe, the September 12 Pisces Full Moon squared the Fed’s natal Venus which conjoins Chairman Bernanke’s natal Sun in Sagittarius. The Fed and its Chairman are getting panicky about how the situation in Europe could impact U.S. banks. Bernanke’s Sun opposite Jupiter in Gemini indicates he is prone to overshoot his arrows. His view is that it is always better to do too much than too little.
Venus conjoining Saturn in Libra describes the Fed rebalancing its portfolio to long term Treasuries. But it also represents the limits of monetary policy. Monetary policy is forcing banks to shrink their balance sheets. Venus (September 29), Mercury (October 6), and the Sun (October 13) conjoining Saturn in Libra indicates there are financial lessons to be learned as monetary policy has become so unbalanced it is about to break Libra’s scales.
Upcoming planetary influences suggest major challenges for the Fed and its Chairman as events occurring during the Pisces Full Moon period (September 12-26) will return in November/December. More policy and/or statement changes are likely to occur at the November 2 and particularly the December 13 FOMC meetings.
Mercury turns retrograde November 24, conjoining the Fed’s natal Venus and Chairman Bernanke’s natal Sun in Sagittarius at the time of the Sagittarius Solar Eclipse. This could indicate a change/reversal in policy communication is underway that is greatly influenced by conditions abroad. Communications could relate to inflation/inflation targeting.
At the same time, Venus in Capricorn squaring Uranus in Aries as Venus conjoins the Fed’s natal Sun and Uranus conjoins the Fed’s Midheaven while both impact the Fed’s Pluto can bring new policy actions that are unexpected. This is a harbinger of when Uranus in Aries turns direct the day of the December 10 Gemini Lunar Eclipse, conjoining the Fed’s natal Midheaven and squaring the Fed’s natal Sun/Pluto opposition.
Communications are a major issue with the eclipse in Mercury-ruled Gemini and Mercury retrograde in Gemini’s opposite sign Sagittarius. The eclipse squares the September 12 Full Moon and opposes the Fed’s Venus and Chairman Bernanke’s natal Sun, likely fulfilling the themes that emerged in November. The Fed Chairman is likely to face hostile opposition from internal and external sources that current policies need to be reversed. Information could emerge relating to a secret financial arrangement that casts the Fed and the Chairman in a negative light. All this comes leading into the December 13 FOMC meeting as Mercury turns direct on the degree of the November 25 Sagittarius Solar Eclipse as Ben Bernanke celebrates his 58th Birthday.
Monetary and fiscal policy intersect as Saturn in Libra squares the Fed’s Neptune in Cancer which exactly opposes the USA’s natal Pluto in Capricorn at the time of the Winter Solstice. Difficult decisions must be made to get the nation’s fiscal house in order and expand the economy. Saturn’s cold hard facts of economic reality conflict with the Fed’s idealistic mathematical models. This could be a turning point for the Fed to initiate a change in course before the nation’s financial foundation is further eroded.
Saturn squaring the USA Pluto occurs at the same time Congress must vote on the deficit reduction committee’s recommendations. It is time to close tax loopholes and deductions that have benefitted only the largest corporations and the wealthiest and most influential individuals. Likewise, the Fed must wakeup to reality that monetary policy has reached its limits.
Federal Reserve: December 23, 1913 6:02 PM EST Washington, DC
Ben Bernanke: December 13, 1953 time unknown Augusta, GA
USA: July 4, 1776 5:10 PM LMT Philadelphia, PA