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Tuesday, August 10, 2010

Brief Thoughts on Fed Action Today

I had a couple brief, and these will actually be brief, thoughts on the Fed's action today.

I don't think the announcement that they will be reinvesting maturing MBSs in Treasuries is actually that substantive as it basically means that the Fed simply is forgoing an otherwise scheduled balance sheet contraction that would have slowly removed liquidity from the system. While that's good, it isn't overly stimulative compared to our current situation except to say that it means we won't have dramatically tightening monetary policy in the near future.

More important than the actual announcement is that the Fed recognizes that economic data has softened notably since May and that the specter we face now is deflation rather than inflation. They didn't explicitly state that deflation is a concern in the FOMC statement today, but implicitly that was there. The key here is that we had to see that the Fed was willing to do more and I was somewhat satisfied that they did. This is good for stocks on two fronts and bad on one. The positives are that the Fed will remain stimulative, helping economic growth and, by extension, earnings. The other is that by buying long term treasuries, interest rates will be depressed, helping stocks appear more attractive as an investment. The bad news is that economic data is weak enough to warrant these actions, which is bad for the earnings outlook, though we haven't heard much from companies indicating that they expect to be taking down estimates. We shall see...

EDIT 8-12-2010: The market certainly seemed to hone in on the third point I broached which is that we only got to this point due to weak economic data and the specter of deflation. I suspect over the next couple weeks that this will be the main focus of the market and every sign of deflation will be greeted with severe trepidation.

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