The Federal Reserve’s statement yesterday added little clarity as to the timing for removal of its unprecedented monetary stimulus. While some of the wording did change, the text of the unanimously-approved statement suggests that FOMC members remain comfortable with the vast amounts of liquidity added to the system in response to the economic meltdown. The Fed still believes that economic conditions are “likely to warrant exceptionally low levels of the federal funds rate for an extended period.” As well, the Fed remains committed to the purchase of huge amounts of agency mortgage-backed securities and unsecured debt through the first quarter of 2010. However, it should be noted that the Fed felt compelled to add a few words that seemed to me like a defense of their decision to stand pat for now. In describing current economic conditions, the Fed included the following factors: “low rates of resource utilization, subdued inflation trends, and stable inflation expectations.” At the risk of reading too much into it, it seems to me like the Fed is beginning to feel more pressure to act sooner rather than later. The hawks, including those within the Fed, have clearly become more vocal recently, and perhaps for good reason.
It sure seems as though Bernanke & Company have engineered a near-perfect V-shaped recovery, doesn’t it? After several quarters of negative GDP growth, we received news last week that the economy grew at a 3.5% annualized pace in the third quarter. Recent reports suggest that manufacturing has picked up, consumer spending seems to have stabilized, job losses have slowed, and even the housing market is showing signs of bottoming. So what is the Fed still worried about? Why not take off the training wheels and appease the pestering inflation hawks?
The problem, which the Fed well understands, is that the economic “recovery” is still far from self-sustaining. Recent positive economic data are first and foremost attributable to government stimulus initiatives. The most obvious example of these initiatives is the cash-for-clunkers program, which sparked consumer spending for a short period of time earlier in the year. However, the number and breadth of stimulus initiatives designed to stabilize the housing market alone is mind-numbing. These initiatives include first-time homebuyer tax credits, artificially-low mortgage rates (as a result of Fed “quantitative easing”), federally-guaranteed mortgage refinancings for up to 125% of the value of a home, fees paid to banks for mortgage restructurings, and many more. The aggregate effect of all these programs seems to have stabilized home sales and prices. In fact, recent data from Case-Shiller suggest that home prices nationwide are on the rise again. But if one takes an objective look at all the government assistance required to get to this point, it’s no wonder the Fed feels like the housing market, like the economy at large, is on a shaky foundation. The removal of any of the stimulus risks putting us back into the throes of the recession. What’s a Fed to do but continue the policies that have succeeded to date? Congress seems to understand the dilemma as well. In fact, the Senate approved a bill last night that will provide another $45 billion in taxpayer dollars to 1) extend and expand the homebuyer tax credits; 2) extend jobless benefits; and 3) provide tax refunds to companies that are losing money.
At some point the training wheels will have to come off. Clearly, neither the Fed nor the Congress believes we are at that point yet. In the meantime, exceedingly low interest rates and a flood of government cash will likely continue to push the dollar lower and asset prices higher – some say to bubble proportions. We have seen this movie before, and it didn’t end well. Therefore, we at Farr, Miller & Washington will remain intently focused on balance sheet strength, quality of management, and valuation. As long as government stimulus is required to achieve economic growth, we prefer to err on the side of caution.