For Fed watchers, and traders, September 2012 was a memorable month: that’s when the Fed launched QE3 also called “QEternity”, a continuation of the “Operation Twist” program that was unveiled earlier in the year, and the Fed’s third – and so far final – asset purchase program which was meant to stimulate the economy but whose real purpose was to push markets higher (as we have now learned).
Today, following the traditional 5 year delay, the Fed published the full transcripts of every conference and meeting held in 2012. This gave us the opportunity to, among other thing, peer inside the minds of then-chair Ben Bernanke, Janet Yellen, various Fed governors and presidents, as to how they approached QE3 in particular, and monetary policy in general in what was a critical period for US capital markets.
What emerges is that, as many had suspected, QE3 was just the Fed’s latest – technically third – major attempt to prop up the US “wealth effect”, which by definition required pushing equities higher, even if – as we have repeatedly shown – only a modest fraction of the US population is actively invested in the stock market.
Here is a notable excerpt from the October 23-24, 2012 Meeting, which took place one month after the Fed formally announced the launch of QE3. The speaker is former Dallas Fed president Richard Fisher, and he immediately makes clear what the purpose ofQE3 was: to boost the market.
MR. FISHER. We have to be very careful. I sensed—let me try to state this politely—a little bit of self-congratulation that QE3 had had such a great impact on the market. Of course it has had a great effect on the fixed-income market. This is a principle of hydrodynamics. It’s Bernoulli’s principle. If you shove a lot of volume through a narrow space, you’re going to get a faster flow. Simon gave a brilliant report yesterday—as he always does—and we saw the reaction in terms of the spreads and what has happened with MBS, and we had some conversations. Governor Powell and I pointed out certain activity, at least in the CCC and lesser category—the junk bond sector—and some of the activities being seen were fully expected. What I didn’t hear was that the stock market is actually down since we previously met by 3.2 percent. It rallied the day after. It’s off 3.6 percent since then.
The real issue was raised by Betsy’s intervention, in my view. I simply want to make the point that I have questions about the wealth effect, and I would like to see further studies on that.
You mentioned that, Mr. Chairman, in your brilliant summary. Stock prices are questionable. How much does it really affect, at least in a reasonable time frame, the median household? And then, Betsy’s point, as I interpreted it, was a key point. And that is, the transmission between MBS prices and what actually happens to the average household—and we think it will take time. I am always thinking at this table: I don’t work for the big banks; I don’t work for the dealers; I work for the average American household, and that is our job. And the question is efficacy. I think it is a little bit too early to judge an effect. Besides that, as we know, despite contradictory data that Governor Yellen presented from Zillow, and so on, the housing market actually took off before we launched QE3. We were not quite sure, but that has been confirmed by the data now. We have to be very careful and take our time to understand what the real effect of what we have done is, in addition to what we see in terms of immediate financial indexes. That is my point.
Don’t worry, Dick, with the Fed’s balance sheet now unwinding, we will understand the real effect of what you have done soon enough.
Next, we note the following excerpt from former Philly Fed president Charles Plosser, who points out something we warned for years, namely that the market no longer responds to micro news or geopolitical developments, but only monetary policy. From the April 24-25, 2012 meeting.
PLOSSER: … the nature of our market economy is to rebound and recover. I fear that we’ve created an atmosphere where many in the financial markets, in particular, are more interested in taking positions that reflect their bets on what monetary policy will do—that is, to QE3 or not to QE3. This can distort market allocations and decisionmaking by investors, resulting in the misallocations of capital and credit, and will have ramifications for our economy down the road. As much as we take signals from the markets and market participants, we need to remember that we have a broader constituency when setting policy.
Ah Charles, the Fed forgot that it has a broader constituency some time in 2008 when it decided that the only thing that matters is preserving equity values and risk assets no matter the cost to everyone else.
Plosser makes another appearance a few months later, in the August 1, 2012 meeting, just weeks before the official announcement of QE3, when the Fed is planning how to unveil the new Large Scale Asset Purchase program. Here, again, we find that it is all about the market.
PLOSSER: In my view, pre-committing today to do something in September is the wrong kind of forward guidance. If we use that language today, then come September, our discussion around this table and the policy decision are going to be tied up in whether we want to disappoint market participants who will have come to believe that we were going to do QE3. And if the data come in stronger, we will presumably disappoint them. I think this is a dangerous commitment and a dangerous signal to send. Once again, this gets back to the idea that in the interest of transparency, our policy path is best laid out in terms of what we are conditioning our policy actions on, not pre-committing to doing something at the next meeting. Instead of this language, I strongly recommend that we keep the language that we used in June and wait to see how the economy performs between now and September.
We next fast forward to the key meeting itself, that of September 13, 2012, when former Fed Governor Elizabeth Duke made the following amusing observation:
DUKE: The Chairman was telling us at dinner last night that he had the opportunity to go and visit the Washington Nationals’ batting practice and meet the players, and one of the players came up and, upon finding that he was the Chairman of the Fed, said, “Hey, how about that QE3, man?” [Laughter] I think this is evidence that there’s a whole world of people out there who have no idea what QE3 actually means or what monetary policy is. They don’t know the Taylor rule, and they haven’t spent much time thinking about the Woodford paper. [Laughter] They won’t read the whole statement or tune into the press conference, but they will likely know that the Fed did something and that that something should help the economy.
Sadly, it did nothing to help the economy; it did everything however to blow the world’s biggest asset bubble.
Finally, here is the WSJ with a tangent on what the Fed’s new chair, Jerome Powell, thinks of QE. Powell joined the Fed board in May of 2012 and is set to succeed Yellen next month. While Powell has been a reliable ally of Yellen, the release of today’s transcripts reveal for the first time his comments behind closed doors at meetings of the Fed’s rate-setting committee.
What the WSJ notes is that while the new kid on the FOMC block clearly did not speak up against QE3, he said that he backed the proposal “with a certain lack of enthusiasm,” and he added, “I am somewhat uncomfortable with the road that we are on.” The decision to purchase assets differed from the crisis-fighting stance of 2008 and 2009, he said, in that the Fed was now resorting to such purchases as “a straightforward jobs program.”
He added, “There is no credible threat of deflation, recession or financial crisis, any of which could present a compelling case for action and the use of all of our tools.” Mr. Powell underscored that his concerns were about the mid to long term, and not the next six months.
He then cautioned that his “concern is that for very modest benefits, we are piling up risks for the future and that it could become habit forming.”
One month later, in the October 2012 meeting, Powell again raised concerns about QE3, noting that markets then assumed the Fed’s portfolio of holdings would grow close to $4 trillion (the balance sheet ultimately reached $4.5 trillion before the central bank began shrinking it last year.)
Powell questioned why the Fed would stop at $4 trillion. “It will never be enough for the market,” he said. “Our models will always tell us that we are helping the economy, and I will probably always feel that those benefits are overestimated.”
He also warned the Fed was at the point of encouraging risk-taking, and that it could be difficult to wind down such a massive portfolio. “We seem to be way too confident that exit can be managed smoothly,” he said. “Markets can be much more dynamic than we appear to think.”
Which sounds like trouble for those market bulls who expect that the Fed will proceed with QE4 (or more) the instant there is even a modest market correction, arguably the principal reason why virtually nobody sells anymore: after all the Fed will always have their back. And while that was certainly the case under Bernanke, Powell appears to be very much against reinforcing such a “habit”… although we are confident that like his predecessors, so “Jay” too will come to appreciate the wonder of the Fed’s money printer if and when the S&P every has a significant correction again.
Finally, here is Powell explaining why he thinks the Fed’s balance sheet unwind will be far more turbulent than everyone thinks:
Take selling—we are talking about selling all of these mortgage-backed securities. Right now, we are buying the market, effectively, and private capital will begin to leave that activity and find something else to do. So when it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response.
So there are a couple of ways to look at it. It is about $1.2 trillion in sales; you take 60 months, you get about $20 billion a month. That is a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80 billion a month.
Another way to look at it, though, is that it’s not so much the sale, the duration; it’s also unloading our short volatility position. When you turn and say to the market, “I’ve got $1.2 trillion of these things,” it’s not just $20 billion a month— it’s the sight of the whole thing coming. And I think there is a pretty good chance that you could have quite a dynamic response in the market. And I would just say I want to understand that a lot better in the intermeeting period and leave it at that. Thank you very much, Mr. Chairman.
Powell’s skepticism has been proven wrong, for now.