A glimmer of light: Fed policy is working

News N Economics, 19 de diciembre del 2008

There is a slew of bad economic news out there, but finally a glimmer of light emerges. The light is dull – a 40-watt rather than 200-watt light bulb- but is nevertheless there: Fed policy is working.

What is Fed policy? Fed policy is massive:

  • Adding $1.4 trillion in liquidity to the domestic and global banking systems via loanable funds and currency swaps
  • Making unprecedented loans to the private sector, American International Group and Bear Stearns
  • Buying agency bonds directly
  • Creating demand in the commercial paper market with $315 billion net transactions
  • Using the Treasury to sterilize inflows
  • On the horizon: buying U.S. Treasuries directly, mortgage-backed securities (MBS), and perhaps other instruments not yet mentioned (CDS, corporate debt, etc.)

Some signs that Fed policy is working:

Corporate spreads are stabilizing if not falling

The chart illustrates corporate bond indices for investment grade and high yield corporate bonds since the beginning of the year. A sign of relief is emerging as corporate bonds spreads – borrowing costs for investment grade and high yield companies – stabilize, even fall.

Corporate bond rates are important – the higher are the costs to borrow, the lower will the borrowing be for new capital investment. See this post to for corporate bond spread indices (against Treasuries) on a longer horizon.

The money supply – all measures of – is growing faster on a weekly basis

And surging on an annual basis

The chart illustrates various measures of the U.S. money supply (the data and definitions are listed here). The growth rate of non-M1 components of M2 (Table 4) started to fall slightly at the end of October, but has since then picked up speed. The 4-week average M2 – a better look at the trend – is growing at a record 8%. Finally, M3 (at least most of M3) is slowing on an annual, but it is reverting back to its longer-term trend rather than falling off a cliff. The Fed is keeping the money supply afloat; this will offset some of the negative price pressures going forward.

Mortgage rates are falling

Who said that traditional monetary policy – cutting the target federal funds rate – was dead, because clearly it is not. In the wake of the Fed’s December 16th announcement, mortgage rates fell with force to 5.27% (as of 7am on December 19th from Bankrate.com). And with the Fed gearing up for its $500 billion MBS program, I expect that mortgage rates will fall further, potentially driving up buyer demand in the housing market.

It looks like the U.S. economy is just skirting a financial meltdown. Phew, now we have a recession to contend with.


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