Tuesday, August 23, 2011

The Day the Fed Put Died?

“I went down to the sacred store
Where I’d heard the music years before,
But the man there said the music wouldn’t play”
Don McLean – American Pie

Ken wrote a timely blog yesterday regarding the upcoming Federal Reserve meeting in Jackson Hole later this week, and how markets might be gaming the possibility of more monetary stimulus to be unveiled. Beyond the Fed’s upcoming rhetoric, I’ve been wondering lately whether the Fed is out of policy options that will have a real effect on business cycles and markets going forward. After all, short-term interest rates have been pegged at zero for some time and two unconventional quantitative easing programs have been enacted.  Yet, none of it has ended the liquidity trap that the economy appears to be in. In short, despite heroic efforts by this Federal Reserve to bring the horse to water, it simply refuses to drink.

Over the past couple of decades, investors have grown to count on the Fed to enact countercyclical policies in times of economic and market stress, and the muscle memory of the markets is programmed to believe that more Fed stimulus leads to higher asset values. But could we be in the midst of a sea change occurring regarding the value of Fed policy? In other words, has the Fed simply run out of bullets? Jackson Hole should give us some clues about the likelihood that Chairman Bernanke will attempt to ride to Wall Street’s rescue one more time. But regardless of whether or not the Fed delivers QE3 on Friday, I think the bigger question to wrestle with is does the Fed still have effective tools it can use to create sweet music for the markets, or are we living through the era that the "Fed put” died? Only time will tell.