Anatomy of a Mistake

compass

The Fed transcripts of the crisis were fun look back at a terrible time. "Analysis" in the media flipped between joking Member comments and Hawk vs Dove labeling. We used the really cool NYT interactive timeline (thank you @thestalwart and @ivanthek ) and overlayed the 12 month LIBOR set. [ Long time readers know that my rule for "Neutral" policy is FF=12mo lIBOR - 60p]...To the tape!..

As the Fed dropped the FF rate from 5% to 4.75 in June of 2007 the Model Neutral projected rate was a close 4.6%. Keep in mind that the suggested rate is the rate at which Fed policy is neither easy nor tight. By Feb/March/April of 2008 FF were lowered from 3 to 2. The 12 month set was 2.80/2.50/2.80 reflecting a NEUTRAL Fed and still jittery funding needs well into the sh*tstorm.

By June Libor spiked to 3.4 and 3.8 in Oct. The fed stood pat at 2% from April to Oct. It was the adjustment UP that finally moved the Fed stance to "Easy". (Not the best way to achieve it btw). Thus, as is almost always the case: The Fed incited the problem with an improperly calibrated stance at the end of incremental tightening AND a too cautious stance well into the relief.

By Oct the FF had dropped to 1% and..oh my..12 month LIBOR hit 1.9%. So after finally providing some support to markets late in 2008 by early 2009 policy was again fairly "neutral." Hmmm, maybe the weak recovery is not so surprising. Since 2009, the rate has been 0 -25 and our model has floated between slightly above and slightly below 0..FOR NEUTRAL. So LSAP (now generically called QE- something we abhor) was a necessary policy.

More importantly, as Tapering has commenced the slide to new forever lows on 12 month sets has continued unabated. We already know how quickly this unintentional "snugging" can ripple through markets thanks to Vince Foster (@extantefactor). (see older posts)  The history shows the unsurprising truth: The Fed started from an improperly calibrated policy point thus attenuating and complicating the path to a needed Easy stance. Today, there is reason to believe their compass is pointing generally North and slowly toward neutral, 65B to go. It is IMPERATIVE that demand for money increase AND FF (General Collateral (GC), whatever) remain on the floor or policy will idle in neutral and the slow slog growth will continue. Bottom line? Without LSAP the Fed isn't nearly as easy as almost everyone believes.

 

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