Steve Blitz Morning Notes

The FOMC is officially worried about growth and deflation risk and they are at the ready to act if need be. Financial conditions have become “less supportive of economic growth” but don’t believe for a minute that the reason rests on ”developments abroad” -- the economic recovery is now “proceeding” rather than “continued to strengthen” while everything aside from business spending is either weak or depressed. The shift of the phrase regarding the “moderate pace of recovery” from starting the sentence about the Fed’s anticipation of a gradual return to full employment in the context of price stability to the end of the sentence and then starting the sentence with “Nonetheless” speaks volumes – in Fedspeak. More surprising was adding that “underlying inflation has trended lower” before their standard line about substantial slack and restrained cost pressures. The Fed is telling us that deflation risk is now on the table.

To underscore their concern about deflation and lower growth, the ”monitor the outlook” phrase was broken out into a separate paragraph. As for Hoenig’s dissent, it had to stay considering that its removal would’ve signaled that the Fed lurched to one step from pressing the panic button.

The FOMC is now confronted with limits of monetary policy when rates are zero. The banking system is stuffed with cash but the liquidity is sitting in reserves at the Fed essentially against legacy assets of too many bad loans and broken securities. The cash isn’t there to lend out—banks haven’t even taken down as many Treasury securities relative to total bank credit as they normally do at this point in the cycle. Nonfinanical corporations are also sitting on a mountain of cash, but it matches a mountain of long-term debt raised to put cash in the coffers and lower the volume of short-term obligations—and net worth is still well below the pre-recession peak. At some point, the corporate cash will go into hopefully productive capital investments, but the opportunities aren’t there yet.

The Fed is officially between the “rock” and the “hard place”