What the Fed Said

Today, I’m wondering if the market was worried that the Fed would announce QE3 at the yesterday’s conclusion of the most recent FOMC meeting. I mean, how else do we explain the 429 point ramp job the Dow Industrials put in?

It may not have been a majority, but there were a significant number of economists who were expecting the Fed to announce the next phase of quantitative easing, or QE3, yesterday.

It didn’t happen.

Instead, Bennie and the Feds (as TradeMaster’s Jason Cimpl likes to call them) promised to keep interest rates at zero until mid-2013. Really. Isn’t that simply confirming what we already knew?

Does anyone out there believe that both housing and employment will pick up to the point that the Fed has to raise rates anytime soon? The Fed could have said 2014 and it wouldn’t have made a difference. This is about as low-risk a move as the Fed could have made.

Seriously, what does the Fed risk by saying lending will come with no interest for another 22 months? All it really means that the Fed won’t make any money from lending for the next two years. I’m having a hard time seeing that as a disaster.

There’s potential for low rates to impact the relative value of the U.S. dollar, but even here, that will depend on how other currencies perform. Like the euro. And heck, there might not even be a euro in 2 years.

The market certainly liked the Fed’s announcement. And quite frankly, I think it’s because the Fed didn’t announce more monetary stimulus. Low interest rates only matter if there’s demand. If people want loans, they can get them, and it won’t cost too much.

Do people want loans? Not really. At least, not right now. So, low rates alone don’t inflate the money supply unnaturally. Low rates don’t spark a bubble, because again, you need demand for that.

In the absence of demand, monetary stimulus doesn’t create demand. We should remember that Alan Greenspan left rates low when demand was increasing. That helped inflate the housing bubble.

The risk for this Fed is that it will leave rates low for too long, and that will be difficult to manage.

The only stimulus that can help the economy now is fiscal stimulus. That’s where the government spends money to employ people to do things, like repair roads or bridges, or build some high speed railways. And given the current environment in Congress, there’s no way any fiscal stimulus will pass anytime soon.

And besides, fiscal stimulus can’t provide 1-for-1 relief. That is, for every the dollar the government might spend, it won’t get a full dollar back in tax revenue or productivity. Whatever the difference is between spending and benefit would be a sunk cost. But as an aside, I’m sure there are plenty of unemployed people out there who appreciate a little sunk cost.

Because, more so than Cash for Clunkers or the First-Time Homebuyers Credit, actual fiscal stimulus can improve the standard of living for an individuals and their families. That’s got to be a better option than ballooning a deficit in order to take a few clunkers off the road.

Not only that, but creating a few jobs might be the only thing that gets a certain president re-elected.

Stock market declines in a presidential election year are rare. And that’s because a president will usually spend whatever it takes to get re-elected (wonder where deficits come from?). Why should this cycle be different?

I don’t know. Look for it. Maybe the reason the Fed didn’t act today is because it knows a big jobs bill is coming down the pike?