The Federal Reserve recants

In the end, it was not even “tapering-lite” when the Federal Reserve Board (FRB) announced its latest policy statement. The FRB apparently judged that:

• the recent sell-off in the government bond markets and associated rise in mortgage rates,
• the still uncertain US fiscal outlook,
• the ongoing, if still largely unnoticed, regulation-driven credit deflation within the banking system,
• the weak underlying state of the labour market, and
• the general deflationary global trade environment

outweighed their own staffers’ concerns over the growing indebtedness in the corporate sector, which the Fed is implicitly encouraging through its current policy settings. The recent softer tone in the housing market may also have been a concern for the Fed’s policymakers, although we suspect that this may have been a peripheral factor for the Fed, given that the previous strength in the housing market was being led largely by a change in the way in which people have been saving, rather than borrowing and spending.

Hence, we suspect that the property market has not been quite as important to the real economy as some might have supposed. More important in the FRB’s calculus, we suspect, was the latest regulation-driven downturn in bank credit and the growing signs of stress within the very important, if largely invisible, “repo markets” on which the banks rely to lubricate their day-to-day operations.

For our part, we can sympathise with the Fed’s dilemma – the choice between: