What The Fed Did Right And What The Fed Did Wrong

I am seeing some questionable commentary. Like this via Bloomberg:

Relying on repo operations doesn’t resolve the issue of reserves declining as the Treasury rebuilds balances, Hornbach wrote in a note. Having regular operations will also increase market uncertainty as the Fed could halt purchases at any time, while the size of its buying will have to expand over time as reserves drop, he said.

Seriously? The Fed isn’t going to randomly halt the repo operations. And yes, they are going to keep increasing the size of the purchases if needed. And if the shortage continues, the Fed is going to boost reserves via permanent open market operations, the dull as dirt balance sheet expansions that happened like clockwork prior to the crisis. Similarly, also this via Bloomberg:

“The next 11 days are going to be a disaster,” Simons said. “If you stack up on both sides the arguments for repo going higher again, it’s all of these things that drain cash out of the market that are persistent issues or unknown but could be persistent. Where are the arguments for repo going lower?”

The arguments for repo rates going lower are 1.) that the Fed just cut the federal funds target by 25 basis points and the IOER rate by 30 basis points, 2.) the Fed can pump as much money as they need to into the markets via repo operations, and 3.) the Fed can expand the balance sheet if they need to.

The Fed is doing the right thing here, using the tools they designed for exactly this purpose. For the most part this is old school central banking. People need to stop living in the last crisis.

That doesn’t mean the Fed is without fault here. Part of the reason for this confusion is that the New York Fed wasn’t on top of this on the morning of day one. The delay made it look like this was some kind of emergency rather than standard operating procedures. Why was the New York Fed slow in responding to evolving market conditions? That’s the story here!

Maybe, just maybe, the slow reaction is the result of eliminating the institutional knowledge. Recall that New York Fed President John Williams shook up his staff earlier in the year. Via Bloomberg:

The sudden departure of two longtime officials shook staff, sank morale and drew attention to the leadership of the New York Fed under John Williams as he enters his second year at the helm. On Wall Street, questions arose again a couple of weeks ago when a speech he gave inadvertently whipsawed markets.

The story involves Simon Potter, who ran the all-important markets desk, and Richard Dzina, head of the financial services group. Both were abruptly relieved of their roles in late May by Williams. Little explanation was given, but according to current and former New York Fed employees, as well as those close to the bank, the nature of the exits, by fault or design, seemed to be a warning: fall in line

The New York Fed plays a powerful role. It is the central bank’s eyes and ears on Wall Street. And as the only regional bank with a permanent vote on rate decisions, it has outsize influence in the financial system. The selection of Williams, a widely respected and oft-cited monetary economist who ran the San Francisco Fed for seven years, for the top job in New York raised eyebrows from the outset. A finance-industry background has traditionally been seen as a key qualification, something he lacked.

Williams, who during his San Francisco Fed days often mentioned his reluctance to pay too much attention to short-term swings in the markets, came under fire on July 18 after saying in a speech that central banks should act quickly “at the first sign of economic distress.”

Yes, well maybe those short term swings in some markets are important. IMHO, financial journalists are chasing the wrong story here. It isn’t that the New York Fed is doing their job with the repo operations. It’s why they weren’t doing their job earlier.

While we are the topic of criticizing the Fed, I am hearing a lot of commentary complaining that Federal Reserve Chair Jerome Powell isn’t in control of the Fed. The supposed evidence is the three dissents at the last meeting which signals a lack of consensus.

Consensus is overrated. I suspect that Powell feels the same way. Responding to a question from the Wall Street Journal Nick Timiraos, Powell said:

Well, let me just say, on the general point of diverse perspectives, you’re right, sometimes, and there’ve been many of those times in my now almost eight years at the Fed, many times when the direction is relatively clear and it’s relatively easy to reach anonymity. This is a time of difficult judgments, and as you can see, disparate perspectives. And I really do think that’s nothing but healthy. And so, I see a benefit in having those diverse perspectives, really.

I don’t think Powell is worried about generating a consensus. And I don’t think he should be worried. Think about the current situation. We clearly know whose opinion isn’t gaining traction, and hence whose opinion we don’t have to spend a lot of time fretting over. And we also know that the FOMC isn’t setting policy to make those people happy, or twisting the policy statement to get their vote. No one is tossing them a bone to get them to come on board with the consensus. This isn’t a bad thing. We are probably getting cleaner policy because it doesn’t have to be the typical product of a committee, something that is fundamentally designed to make everyone on the committee happy.

Also hearing commentary that Powell isn’t a good communicator, and not just from President Trump. So on this point, sure, Powell’s conversational, off-the-cuff style hasn’t always been the best for the job. We, including myself, will tend to read too much into errant remarks, largely because we all worry that we are on the wrong side of the call and no one likes to be on the wrong side of the call. That said, I think a fair comparison of this week’s press conference with the last reveals that Powell is modifying his approach. This week he appeared to anticipate questions much better than in the past and not start some story like “mid-cycle adjustment” that forced him to back up over himself and then turn back around. It was a clean, solid performance.

The only question that I thought received a less-than-satisfactory answer was that by the Washington Post’s Heather Long:

Hi, Heather long from the Washington Post. Mr. Chairman, in your view, is there any risk to the United States having much higher interest rates than Europe, and Japan, and other parts of the world? Is there any risk to the U.S. Economy to that divergence or any risks to the global economy?

The dollar is a critical element of the global financial system. My instinct is that the Fed can not set rates higher than the rest of the world without stressing the entire system. I think the Fed needs to think about this more, at least that was my response to Powell’s answer.

Bottom Line: There’s valid criticism of the Fed, and there’s invalid criticism. I worry that the apparent dominance of latter drives overly bearish conclusions.

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