Monday, April 27, 2009

Fed Discovers Ideal Interest Rate Policy

The good news is that a Fed study has revealed the perfect interest rate for the current economic climate. The bad news is that the interest rate is -5%. Unfortunately, knowing the solutions to our economic woes and being able to implement them are two different things, as it is impossible for the Fed to lower rates below zero. However, the Fed can enact unconventional policies that provide stimulus roughly equivalent to an interest rate of minus 5% (i.e. quantitative easing.) The Fed staff separately estimated what size and type of unconventional operations, including asset purchases, might provide this level of stimulus. Apparently, it is far more than the $1.15 billion increase that policymakers authorized at the last meeting. Clearly we’re looking at zero interest rates for some time to come. Investors from now on will focus less on what the Fed’s stated interest rate policies are and instead turn their attention to how many securities the bank intends to purchase.

Meanwhile, in the repo market, where investors go to finance their securities, interest rates for certain scarce issues are already trading at negative interest rates. This situation will only be further exacerbated by the Federal Reserve Bank of New York’s suggestion that banks be charged a three-percentage point fee for failing to deliver securities. The new fee is intended to discourage failures and make Treasury repo transactions much smoother. Whether it will work or not remains to be seen, as a fee on failures to deliver may encourage even more hoarding of scarce issues. The only thing that’s certain is that dealers will figure out how to game the new system to their advantage. After all, it is what they do best.

The Fed, with all of its quantitative easing, is attempting to encourage risk taking in the economy again. With a zero interest rate policy, banks are supposed to be lending and, to a certain extent, passing on the savings to consumers. With the recent announcement made by several large banks that they are actually raising fees on credit card customers coupled with the scarcity of financing for any type of mortgage that isn’t conforming (i.e. provided by the government,) the Fed’s policies have only served to fatten banks’ profits (i.e. keep them alive for another quarter.) Investors, however, are dipping their toes back in the market, as spreads in the bond market have narrowed and equities have rallied off of their depressing lows hit on March 9th. This is marginally positive news.

What happens if interest rates are negative and you are still not ready to jump back into the stock or bond markets? What if you’re sitting on the sidelines and your bank decides that it is going to start charging YOU for the privilege of holding your money? It’s a wonder that mattress sales haven’t gone through the roof.


anonymous said...

Looks like the government's gun is being put to savers' heads, simultaneously saying "go long punk..."

K10 said...

no kidding.