Aug. 12, 2011, 8:11 a.m. EDT
Bernanke is bold; now it’s Obama’s turn
Commentary: Fed’s interest-rate move not a cure-all
By Brian Edmonds
NEW YORK (MarketWatch) — It’s starting to feel like déjà vu all over again.
Having traded through the crisis of 2008 and all the major financial crises since the 1987, crash, I thought I had seen it all. But this month -- and we are not even halfway through -- has truly been unprecedented, starting with the debt-ceiling debacle and all the way through a very surprising FOMC decision.
On Tuesday, Chairman Bernanke and the FOMC (with three members dissenting) acted in response to our sputtering economy and announced a bold new policy extending the zero Fed Funds rate until mid-2013. With this bold step, Bernanke has made it clear that this Fed will not sit idly by. By locking in low rates, the Fed has expressly made stocks more attractive according to any equity pricing model, and it has also helped push U.S. rates to historic lows across almost the entire yield curve.
Two-year Treasury rates are now under .20. Some have described this move as quantitative easing, without using the Fed balance sheet. Treasury investors have been forced out of the curve in search of yield, and 10-year Treasury rates have fallen from 2.75 at the beginning of the month to a low yield of 2.03 earlier this week. Conceivably, this action will also force investors into risk assets in search of returns, as all Treasuries shorter than 10 years offer yields less than current inflation rates.
This bold move is not without risks, and it would seem that the Fed has declared that it believes this economy is very troubled. After initially rallying, the stock market has gyrated wildly and gold has soared to record highs. Still, I applaud this move, not so much because I agree that that Fed policy will solve all, but because I believe this is a time for bold steps and real action, and Bernanke will go down in history as someone who did everything he could.
Ultimately, if the economy does not respond, the Fed will continue to do what it can by taking away interest paid on reserves held at the Fed, and possibly resume purchasing longer term Treasurys. In other words, QE3. Or, it could even purchase equities or other targeted asset classes directly. The Fed might have a limited arsenal, but make no mistake: Chairman Bernanke and the FOMC will continue to act, if necessary.
Contrast this with Capitol Hill. We finally got a deal that raised the debt ceiling limit but did little to resolve our country’s long term deficit problems, and in the process we exposed fiercely divided and flawed political leadership.
Early this week, President Obama responded to the S & P downgrade by saying that no matter what some rating agency says, we’ve always been and will always be a AAA country and that the markets continue to reaffirm our credit as among the world’s safest.
The president is correct that U.S.Treasurys have held up well after the downgrade, as investors rushed to the safety of Treasurys, just like they always have in past crises. Treasurys have also benefited from the Fed easing action this week, and even AAA rated corporate bonds have cheapened versus AA+ rated Treasurys.
But over time, if we do not resolve our long-term deficits, U.S. interest rates could rise precipitously and our status as global, risk-free benchmark could be lost, forever. This debt ceiling fiasco has already done much damage to our global status, and I imagine many investors worldwide are seeking alternatives to U.S. Treasurys.
It is time for President Obama to take the lead: Call Congress back into session and take real steps to rein in government spending and budget deficits. Now is not the time for modest adjustments - now is the time for bold action.