A Forex View From Afar

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One-step forward or one-step back?

Written by A Forex View From Afar on Friday, March 20, 2009

The Fed’s decision to buy up to $300 billion of long-term Treasuries and double the purchases of mortgages to $1.45 billion was a surprise to most market participants.

The surprise is even bigger, if we add that just two weeks ago the Chairman of the New York Fed, seen as the second man in Federal Reserve, said “at this point in time the Fed has judged buying long-term Treasuries is not the most efficient means of easing financial market conditions”. This is a huge change in just two weeks, and it certainly raises some questions as to why the Fed made this decision, if it is not efficient.

Moreover, Mr. Bernanke has build an academic reputation as a supporter of the inflation targeting regime, which implies that the central bank must be as clear as possible in its actions. The Fed’s past actions have proven that the central bank follows these general guidelines, since the central bank has anchored expectations pretty well (until now).

In the last few years, the Fed has gone through some major changes with Mr. Bernanke at the rudder, and has mostly, managed to break free from the Greenspan era, when market participants focused on how many times the Chairman blinked, or where he looked when he spoke, rather than what he actually said. Mr. Greenspan spoke most of the time in “riddles” that gave some major headaches because the message was never fully understood.

The decisions taken yesterday (to intervene in the debt market without anchoring the market’s expectations first) remind us of the Greenspan era, something that is not very positive from my point of view. Yes, it was a true shock and it had clear effects in the financial markets, but it is still a question of how positive these effects will be in the long-term. If, supposedly, the market/economic conditions continue to deteriorate, the market will expect the Fed to provide another shock. If the FOMC fails to provide it, the financial markets will be very disappointed.

Another problem with the Fed’s statement issued yesterday is that it does not clarify how they have chosen the sums. Why they chose $300 billion for Treasuries, and $750 for mortgages is still unknown, but my guess if that the officials will clarify this at some point in the future, since this is not such a major issue.

The overall conclusion would be that the Fed had communication issues yesterday, and from my point of view took a step backward instead of the forward. Referring to the actual decisions taken yesterday, the markets still need time to clarify how effective they really are.

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