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Fed Should Resist Market Pressure To Do More; The Consequences Of


In listening to market chatter urging the Federal Reserve to do more, I’m reminded of two simple insights I was exposed to years ago that have stayed with me. They don’t help predict what the Fed will end up doing, but they help shed light on the possible consequences.

Early on in my career at Pimco, I remember Bill Gross, the firm’s founder and legendary investor, reminding portfolio managers that “there are times when the best thing to do is to do nothing.” It’s important advice as most PMs are conditioned to continuously look for opportunities and react accordingly. They naturally get fidgety when market conditions dictate that the best thing to do is simply wait. The cost of ignoring Gross’s advice ranges from unnecessarily wasting money on bid-offer spreads to ending up with less-optimal portfolio positioning.

Gross’s advice should be heeded by Fed officials who are under pressure by markets to do more, including some combination of negative interest rates, yield-curve control, larger asset-purchase programs and more aggressive forward guidance – all of which, from a narrow market perspective, would help push even more investor money into risk assets such as stocks and high-yield bonds, thereby pushing their already elevated prices even higher. Yet there are few, if any, valid economic policy reasons to do so.

Consider four often-cited reasons for exceptional monetary policy actions:

Market functioning: After notable disruptions, U.S. financial markets are liquid and functioning well because of the Fed’s emergency policy interventions, which, as Chair Jerome Powell acknowledged last week, “crossed a lot of red lines that had not been crossed before” as the central bank found itself in a “situation in which you do that, and you figure it out afterward.”

Market volatility: Government interest rates have been rather range bound in recent weeks with the 10-year yield ending May broadly unchanged from a month ago. The portions of the yield curve that the Fed can more easily influence have also been well behaved. For example, the spread between two- and five-year Treasuries, the so-called 2s-5s, is at a comforting 14 basis points. And all this comes in the context of record borrowing by the government and also record corporate bond issuance by investment-grade companies.

Credit flow: Most companies with capital market access have had no problems issuing bonds. In fact, at more than $1 trillion, the pace of issuance the last few weeks has been the highest on record. Moreover, this issuance has been undertaken at a relatively low cost given both repressed Treasury yields and risk spreads.

Economic activity: While the economy is challenged in multiple ways, it’s hard to argue that this is due to financial conditions that the Fed influences. Consider housing as an example. As noted by the St. Louis Fed, the average rate on 15-year fixed-rate mortgages was at its lowest level (2.62%) since May 2013.

Having said that, the Fed could well be tempted…



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