Easing at the Zero Bound

Our Fed Funds equilibrium rate model projects a rate of 20bp up  from the 15bp of recent months. The Fed, by default, is now  "easier" as force must be applied to keep the rate from rising. The purpose of other Fed programs and facilities  (QE)is to apply additional monetary stimulus when the equilibrium rate gravitates toward zero (in practice 12bp). In other words, when the equilibrium rate for Fed Funds and the observed rate are roughly the same, a.o.t.b.e., the Fed is NEUTRAL.

The generic terms QE 1 and QE2 are in market practice referring to LSAP (Large Scale Asset Purchases). The most effective aspects of QE1 were the panoply of facilities initiated to address broken market structure. QE2 was an additional LSAP program aimed at boosting growth rates after the facilities were wound down. Market participants are now dealing with positioning oriented to 2 remaining Fed tools after stronger language was utilized in the last meeting. The economic back drop clearly weakened but it is important to note that the stronger language did help drive term structures lower without actually "doing" anything of substance.

Cutting the IOER rate is technically a tricky tool. Distortions could emerge with FF and FDIC fees could hinder already tender bank cost structures and MMF relationships. A cut to 10-12bp could "normalize" other short rate terms given the 2013 ZIRP "promise." We advocated for a cap on the payments above the present level. The wildly more popular, yet placebo efficacy, of extending duration in the Fed's portfolio is the other option. Few proponents have associated the activity with a metric to evaluate success (other than twisting) and most contain conspiratorial interactions with the Treasury Dept. Twisting without attaching an upward revision to the economic outlook is silly. A sterilized twist at the existing balance sheet size is not additional accommodation, thus greater LSAP will have to be entertained. The ZIRP promise is much easier to align with a nominal GDP target than duration extension.

Emerging Market countries that had to lean against the rising inflationary pressures have returned to more neutral stances. Other Developed Market economies can do more to ease their debts and anemic growth. Extreme measures will be with us for a long time. Zero is no longer the lower bound.

 

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