In Between Days: Trichet, Bernanke and Obama

by CC September 8, 2011 12:27 am • Commentary

Although most attention tomorrow will be going towards President Obama’s speech on job creation in the evening, the market will be more focused during the day on any clues offered by ECB honcho Jean-Claude Trichet at 8:30am ET and then Ben Bernanke at 1:30pm ET

Tomorrow’s Tape: Talk Is Cheap


  • 8:30 a.m. ET: We get weekly jobless claims. Economists think they came in at about, you guessed it, 400,000.
  • 8:30 a.m. ET: We also get international trade data for July. Economists think the trade gap narrowed a bit from ginormous to gargantuan.
  • 3:00 p.m. ET: We get consumer credit data for July. Economists expect to see a smaller increase after a huge jump in June.

FedSpeak Etc.:

  • 7:45 a.m. ET: ECB Rate Announcement: Nothing will happen here. The fireworks will come at…
  • 8:30 a.m. ET: ECB Press Conference: Will Jean-Claude Trichet promise an end to rate hikes?
  • 1:30 p.m. ET: Ben Bernanke gives a speech on the economy. Will he snuff or encourage hopes of more QE?
  • 7:00 p.m. ET: President Obama gives a speech announcing a job-creation plan, which the GOP will probably shoot down anyway. Good times.


Federal Reserve officials are considering three unconventional steps to revive the economic recovery and seem increasingly inclined to take at least one as they prepare to meet this month.

Worries about inflation at the Fed have receded in recent weeks and economic data have worsened, putting officials on the lookout for ways to spur economic growth and improve financial conditions.

Chairman Ben Bernanke speaks Thursday in Minneapolis, and is likely to reiterate that the central bank is studying all its options, before officials meet Sept. 20 and 21.

Other Fed officials, meanwhile, are expressing support for additional action.


Federal Reserve policy makers are laying the groundwork for further action at this month’s meeting, warning that U.S. economic growth could stall, producing lasting stagnation in the job market.

Federal Reserve Bank of Chicago President Charles Evans said yesterday the Fed should consider adding “very significant amounts of policy accommodation” and attacked the notion it should abide by a 2 percent ceiling on inflation. San Francisco Fed chief John Williams cited “a number of steps” that could be taken to support growth, without offering specifics.

The Fed may decide at its Sept. 20-21 meeting to replace some of the short-term Treasury securities in its $1.65 trillion portfolio with long-term debt in a bid to lower rates on everything from mortgages to car loans, according to economists at Wells Fargo & Co., Barclays Capital Inc. and Goldman Sachs Group Inc. Some analysts dub the maneuver “Operation Twist” because it would bend long-term yields lower. Fed Chairman Ben S. Bernanke is due to speak in Minnesota today on the economic outlook at 1:30 p.m. New York time.


Under ‘Operation Twist’ the Fed changes the target of its Treasury purchases from short-term paper to longer-term paper. To use official parlance, it extends the duration of its SOMA portfolio.

In the current environment this serves two important purposes. By shifting out of short-term Treasuries the Fed eases supply constraints on the short-end of the Treasury repo market, which can help avoid negative pressure on repo rates (stops them going negative). For why the Fed would want to avoid negative rates at any cost in a debt deflation environment see here.

The other important function it serves is that it helps flatten the interest-rate curve, easing interest-rate expectations for investors over a longer time-frame, and hopefully encouraging them to borrow for longer, investing in more risky securities as they do.

But you can also think of it from the point of view that Treasury securities carry inflation risk in their own right (the more inflation rises, the less profitable your Treasury investment is). By extending the duration of its purchases the Fed is taking that inflation risk out of the market and putting it into its own SOMA portfolio.

Indeed, by changing the yield curve in a way that disincentivises holding Treasuries in an inflationary environment Ben Bernanke is hoping people will start putting their money elsewhere. He’s stamping out inflation expectations in the Treasury curve.

But… there is a massive danger with this policy. It simultaneously encourages a deflationary long-term view. Thus, essential to Operation Twist is that inflation expectations are supported at the same time. If they are not, the scramble for even low yielding long term paper could very well continue. The worst-case scenario of that could be that deflationary expectations are extended.

Now, if deflation did become a reality rather than a fear, Operation Twist will have done the exact opposite of its actual intention. Rather than encouraging lending by taking inflation risk out of the interest-rate market by putting it onto the Fed’s own shoulders, it would have injected deflation risk into the market while stocking the Fed’s SOMA portfolio with deflation compensation securities.

So how to avoid these unwanted deflationary/inflationary side-effects?

If you work with the premise that QE2 led to what has been described as’bad inflation’ — inflation being exported into commodity and emerging market securities rather than domestic ones — you could argue the Fed has always had an interest in sterilising that inflation effect.

It’s a point that was recently made by Hilda Ochoa-Brillembourg, founding CEO of Strategic Investment Group and former director of the World Bank/IMF Credit Union, in the Huffington Post:

Given that the Federal Reserve (Fed) mandate calls for managing inflationary and employment trends and that inflationary pressures may prematurely hinder sustainable employment gains, it may be time to consider Fed counter-trend intervention in the commodity markets. Assuming the Fed would be able to bring inflation under control when it does rear its head, selling commodity futures to sterilize core inflationary pressures generated by quantitative easing might not only reduce the chances of a stagflationary outcome but might even be a very profitable trade for the Fed.

Selling commodities into increased speculative demand for commodity futures would reduce the self-feeding loop of inflationary expectations and financial speculation in the commodity markets. The Fed has not hitherto engaged in this type of monetary “sterilization,” but sterilizing a portion of interest rate intervention would be akin to sterilizing currency interventions as has been done in the past in a few countries to reduce the likelihood of inflation from intervention in the currency markets.


The S&P 500 opened with a giant pop in the first five minutes, up about 1.4%, and doubled the advance to close at the daily high of 1198.62, a gain of 2.86%. The Fed’s Beige Book, data though August 26th, led with the observation that “economic activity continued to expand at a modest pace.” That was sufficient for the market to lock in the gains. The index is in the red year-to-date at -4.69%, which is 12.10% below the interim high set on April 29.

From an intermediate perspective, the index is 77.2% above the March 2009 closing low and 23.4% below the nominal all-time high of October 2007.