Frank, Further

By: Michael Ashton | Tue, May 3, 2011
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As if the Federal Reserve didn't have enough problems, what with a mandate which conflicts with itself and an army of academics trying to wrestle real-world problems into their models, they also have to deal with Barney Frank. Today Congressman Frank introduced legislation that would take away the power of regional Fed Presidents to have a vote on the Federal Open Market Committee (FOMC).

Now, there should be no illusions about the actual power that regional presidents have. While they technically vote, and can (and often do) dissent, there is virtually no chance of a regional Fed President, or for that matter any of the other (appointed) members of the FOMC, leading a coup and actually out-voting the Chairman. I should take away the "virtually" in that sentence - it's just not going to happen. No Chairman has ever even recorded a close vote, much less lost a vote. For all intents and purposes, there is only one vote that matters, and that's the Chairman's vote.

While that is true, however, the technical formal power of the other FOMC members ensures that the Chairman cannot just ram through whatever policy he wants without at least some discussion, negotiation, compromise, and cajoling. Having input from members who are closer to the actual business of the country is an important feedback mechanism, if it isn't really a very good check on the power of the Chairman.

And Frank's objection is, in fact, that these people are businesspeople and appointed by other businesspeople, rather than being entirely political creatures appointed by the President and approved by Congress, as the permanent members of the FOMC are. To Mr. Frank, this means that they can't be trusted because they haven't been "vetted" by the noble servants of the people. More realistically, his objection is that because these members haven't been put through the confirmation process, politicians haven't had a chance to extract their tithe and can't control the Fed by packing it with like-minded (read: always dovish) people. Like most of what Frank has done and has always tried to do, this is another attempt to centralize more power in the hands of the Congress. It is a very bad idea (as if you needed me to tell you that!).

But then again, the Fed is such a mess perhaps making it a puppet of the branch that votes the budget will just make the whole arrangement more explicit: you print, we spend. So maybe we just reach the denouement more quickly this way.

The Frank news did not have a discernable effect; nor did the news this afternoon that Portugal agreed on a $116bln bailout package and associated austerity measures. This latter isn't terribly big news; the "agreement" is between Prime Minister Jose Socrates and EU officials and still must be agreed to by other political parties in Portugal as well as all of the member EU nations. This is only a start. Wake me when the Finns have to vote.

The stock market endured a small decline on the day, while bonds rallied slightly. The real action again was in commodities, where Silver continued to decline. The 2-day drop is now around 12.5%. Today Crude oil also dropped by 2%; front Crude is now "only" $111 even as retail gasoline price increases continue. The AAA retail gasoline price today was $3.967, only a shiny dime and a shiny nickel away from the July-2008 highs. This is one reason the President's popularity bounce from getting Osama will be short-lived. "Glad you got him, tell me how I can fill up my Range Rover." As I mentioned yesterday, removing Osama bin Laden is a nice symbolic result, but oil prices are not high from terrorism but from unrest and geopolitical risk in the MENA region. That remains today (and I can't imagine it will get better if Obama shows pictures of Osama's remains, as is the current crazy plan).


One quick addendum to yesterday's note, which I hope you read if you haven't already. I should have mentioned that another reason excess reserves are being used to deploy loans only very slowly is that the Fed continues to pay Interest on Excess Reserves. The 25bp interest rate seems very low, but it still tends to keep the cash on the books. As I have said before, "pay for excess reserves and you get excess reserves." This is not shocking, and since at the moment we really don't want that $1.5 trillion to be flushed into the system it isn't even a bad thing although it does raise the question of why the Fed injected $1.5 trillion in the first place. Hearkening back to yesterday: this would be a very good way to decrease velocity on purpose, if that is what you want to do. Force reserves into the system, and then give banks a reason to sit on them.


The ramp-up to Friday's Employment number starts tomorrow with the monthly ADP report (Consensus: 198k vs 201k last). The last three prints have been 190k, 208k, and 201k, so the consensus is right on the average. That's a cop-out. If the economy is improving, it needs to be adding more jobs than that. If it's rolling over, then it'll surprise on the downside. Take a stand! The entire range of estimates reported on Bloomberg is 164k to 240k with a standard deviation of 19k. The last time the variance was that low, in January, ADP missed by 200k from the consensus. That's not causal, of course; it just helps to illustrate the clustering effect. The monthly standard deviation of the number is around 75k over the last year.

The question, of course, is which kind of miss will have a bigger effect? On bonds, which have recently rallied to near the highest levels since November (the 10y yield is 3.25% on today's close), a stronger-than-expected number seems to me to have the most potential for adverse market reaction, but stocks certainly don't seem to have a sufficient short base to give much liftoff in the event of such an outcome. In other words, I guess I'm saying that for choice I'd be short both stocks and bonds tomorrow, because a reaction to the downside is in my view likely to be the more-virulent in each case. That being said, ADP is still ADP and while the recent string of steady numbers (and the last two, actually pretty close to the Payrolls figure itself) will tend to increase focus on the data, it is still not the week's main event!



Michael Ashton

Author: Michael Ashton

Michael Ashton, CFA

Michael Ashton

Michael Ashton is Managing Principal at Enduring Investments LLC, a specialty consulting and investment management boutique that offers focused inflation-market expertise. He may be contacted through that site. He is on Twitter at @inflation_guy

Prior to founding Enduring Investments, Mr. Ashton worked as a trader, strategist, and salesman during a 20-year Wall Street career that included tours of duty at Deutsche Bank, Bankers Trust, Barclays Capital, and J.P. Morgan.

Since 2003 he has played an integral role in developing the U.S. inflation derivatives markets and is widely viewed as a premier subject matter expert on inflation products and inflation trading. While at Barclays, he traded the first interbank U.S. CPI swaps. He was primarily responsible for the creation of the CPI Futures contract that the Chicago Mercantile Exchange listed in February 2004 and was the lead market maker for that contract. Mr. Ashton has written extensively about the use of inflation-indexed products for hedging real exposures, including papers and book chapters on "Inflation and Commodities," "The Real-Feel Inflation Rate," "Hedging Post-Retirement Medical Liabilities," and "Liability-Driven Investment For Individuals." He frequently speaks in front of professional and retail audiences, both large and small. He runs the Inflation-Indexed Investing Association.

For many years, Mr. Ashton has written frequent market commentary, sometimes for client distribution and more recently for wider public dissemination. Mr. Ashton received a Bachelor of Arts degree in Economics from Trinity University in 1990 and was awarded his CFA charter in 2001.

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