Randomly Noted

This may be a case of  over-the-top tea-leaf reading.

So, by definition, it will be convoluted. But here goes. My interpretation of some comments made today byFederal Reserve Vice Chair Janet L. Yellen indicates the central bank will feel no rush to remove the famous “extended period” language from its post-meeting statements.

The reason for that, essentially, is that Yellen thinks the Fed’s conditionality around that phrase has been sufficient to allow market participants to change their views about when the central bank may finally come off its long-standing emergency easy policy, which features zero short-term interest rates. Said another way, the phrase “extended period” is flexible.

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If there is, as widely perceived, a broad backlash against elected officials in the U.S. for essentially trying to do to much to revive the economy without overwhelming success, something similar may be brewing against an equally important if unelected group of public officials.

Election day, next week, will better prove the level of unease within the populace about the gobs of fiscal stimulus and other programs designed to get things growing. While surely having kept the 2008-09 economy from smashing up completely, these programs leave us still in a slow-growth, high unemployment state of affairs.

The decision makers at the U.S. Federal Reserve won’t have to stand for such a stark verdict on their performance, but recent criticism of coming central bank efforts to spur the economy move along a similar track.

To put the biggest ring around this apparent backlash, we’ll take the outlandish position that it’s about the limits of human ability. Specifically, the question is this: how effectively can human beings manipulate a capitalist economy, part of a larger global collection, as big and complex as that of the U.S.?

If capitalism is built on the notion of an invisible hand guiding millions of self-interested decisions that taken together make the whole increasingly larger, today’s backlash questions the power of the visible hand: that of government action.

In the case of the Fed, its the much-hinted quantitative easing phase II, expected to be announced next week, that’s drawing the latest backlash.

In past posts, I’ve called it fix-it fatigue. It’s a weariness with plans that seem to try to mask some fundamental imbalances that occurred over a long period of time. Those imbalances may need to be sorted out once and for all, no matter how long or painful the process.

The deleveraging of an overleveraged economy. The discovery of a clearing price for housing in an overbuilt market. Those sorts of things.

The Fed’s interest in doing what it can to fulfill its dual mandate of sustainable high employment and steady and controlled inflation is understandable. Quantitative easing simply might not work. It simply could create bigger problems later on.

The backlash says let the Fed try to do less. Here’s Jeremy Grantham, of the Boston-based fund management firm GMO, writing recently: “I would limit its (the Fed’s) activities to making sure the economy had a suitable amount of liquidity to function normally. Further, I would force it to swear off manipulating asset prices through artificially low rates and asymmetric promises of help in tough times …It would be a better, simpler and less dangerous world.”

Noting that some economists believe it can take many, not several, years for economies that are delevering to get back to a steady state, William Gross, managing director of the asset management firm PIMCO, recently wrote: “The Fed, on Wednesday, however, will decide that it is better to keep the patient on life support with an adreneline injection and a following morphine drip than to risk its demise and ultimate rebirth in another form.”

The fix-it fatigue view says too much money, from fiscal budgets and quantitative easing, will pile up generations of debt and create a new round of asset price bubbles. As bad as things are, this argument goes, we’re not collectively clever enough to find short cuts to fix them.

Could the ‘flash crash’ of last May hurt the Federal Reserve’s effort to reflate the U.S. economy? Below is a wholly speculative connect-the-dots execricse that will, if nothing else, report on a disturbing trend in stock market investment.

Let’s start with the Fed’s presumed goals in embarking on another round of so-called quantitative easing, which the central bank is widely expected to launch after its November monetary policy meeting. The Fed is expected to resume purchases of Treasury securities, thereby pumping more money into the financial system.

Some of that additional money is expected to be invested in riskier assets (since bond returns will be held down by Fed buying). Those riskier assets include stocks. Higher stock prices would mean more wealth (at least on paper) and presumed increased consumer spending, leading to more demand, more job creation and lots of other good things.

Even at best, there are a lot of co-dependent events in this scenario.

The new concern is that individual investors appear to be staying out of the U.S. equities markets, despite the third quarter share price run-up that ususally draws them in.

“In the past 25 years, there has never been a three-month gain in the S&P 500 of 10% or more that was not accompanied by net inflows into equity mutual funds and Exchange Traded Funds,” wrote Jeffrey Kleintop, chief market strategist of LPL Financial, citing data from the Investment Company Institute.

Yet so far in the second half of 2010, Kleintop wrote, the S&P 500 is up about 15% and individual investors have been net sellers every week.

Kleintop thinks it has a lot to do with the “flash crash” of May 6, when stock prices swooned historically only to mainly snap back before the day’s trading was done. Individual investors “remain distrustful of the integrity of the U.S. stock market,” he wrote.

Others have cited signs of an increased professionalization of the U.S. stock market, with volumes pumped by high frequency traders. “Without the return of the individual investor to the U.S. stock market, further gains in the current rally may be hard to come by,” Kleintop said.

That brings us back to the stretched causal relationship mentioned up top. A “flash crash-” traumatized individual investor sector might keep stocks from continuing to climb, upsetting the Fed’s strategy for a bit more inflation and more noticeable economic growth.

In the debate about how much of the U.S. unemployment problem is due to factors beyond the flat economy, the chairman of the Federal Reserve has weighed in: not enough to keep the Fed still.

In his much-anticipated speech this morning in which Fed Chairman Ben Bernanke signalled another round of quantitative easing is coming soon, he also noted the obscure issue of how much of the unemployment rate is due to structural factors.

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“It doesn’t do the chairman any good to have everyone sit around the table and tell him how smart he is” and that his policies are the right ones.

The chairman in question is Ben Bernanke, leader of the U.S. Federal Reserve. The speaker is James Bullard, president of the Federal Reserve Bank of St. Louis, who spoke today with a group of reporters and editors from Dow Jones Newswires and The Wall Street Journal.

The quote was a partial response to a question from this columnist, who offered the notion that Bullard seemed to be the pre-eminent member of a small club of central bank policy makers who have lately spoken more forthrightly on pertinent issues, such as quantitative easing, than is the tradition among central bankers.

Late last year, we referred to Bullard as a breath of fresh air for that very practice. And the recently installed president of the Federal Reserve bank of Minneapolis, Narayana Kocherlakota, sprinkled a recent speech with provocative talk about structural problems in the U.S. labor market, among other issues. Meanwhile, the president of the Federal Reserve Bank of Kansas City, Thomas Hoenig, has become the lone serial dissenter, insisting the economy is healthy enough to survive merely easy monetary policy, rather than the emergency zero short rates that we have had for some one and three-quarter years.

Substantively today, Bullard repeated his view that the Fed needs to stand ready to take further action if the economy falters and already below-target inflation dips more dangerously towards deflation. He believes the best way to achieve this would be through incremental purchases of Treasury securities. He said he doesn’t think further action will be needed.

Those views areen’t very different than those expressed recently by the aforementioned chairman, Bernanke.

Citing his own bona fides that include 20 years of monetary policy work (and two-plus years as the St. Louis Fed leader), Bullard said today Bernanke is not fazed at all to hear different ideas about the state of the economy and potential Fed responses.

As for outreach, much appreciated by journalists and of real value to all interested citizens, Bullard said the Fed needs buy-in to have effective policy.

“These are extraordinary times for monetary policy,” Bullard said, making it incumbent on people in the system to explain things as best they can. Bullard is currently a voting member of the policy setting Federal Open Market Committee.

Indeed, those policies will be more effective if they are better understood by the public, he said.

Another part of that impudent question went something like this: had there been any pushback in Washington against Bullard’s plain speaking. There’s been “no pushback at all,” he said.

Reading the minutes of the rate-setting Federal Open Market Committee’s meeting of Aug. 10, one is struck by the two uses of the word “anticipated.”

In both cases, the minutes, released today, talk of anticipations by Federal Reserve policymakers that were not being met. Both those thwarted anticipations are on the downside for the recovery and the resumption of more usual economic conditions in the U.S.

Example one: “members generally judged that the economic outlook had softened somewhat more than they had anticipated, particularly for the near term, and saw increased downside risks to the outlook for both growth and inflation.”

Example two, which follows shortly afterwards. “Members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated.”

The dual mandate is to maximize employment andto keep inflation under control. Ususally that means keeping inflation from rising. Now, the tougher concern is that the inflation rate is too low.

It is in the interest of  the U.S. Federal Reserve to downplay its decision to reinvest the proceeds of agency and mortgage-backed debt back into Treasury securities. In reality, it’s not a monumental move.

But it shows again that the currently constituted U.S. central bank  would rather be doing than watching as the economy continues to struggle.

No doubt the lessons of the Great Depression – an academic specialty of Fed Chairman Ben Bernanke – and Japan’s deflationary decade loom large for the central bankers as the U.S. economy’s growth becomes less perceptible and inflation declines to potentially unhealthily small numbers.

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It’s the minimalist Federal Reserve.

With a tad of old-fashioned ‘white out,’ the U.S. central bank could have taken its statement issued at the conclusion of its March 16 policy meeting and re-issued it today to mark the end of its latest interest-rate confab.

Even Thomas M. Hoenig, the honorable dissenter on the Federal Open Market Committee, if left to repeat his solitary stand meeting after meeting.

Hoenig, the president of the Federal Reserve Bank of Kansas City, doesn’t want much, just for the Fed to abandon its phrase that near-zero short-term interest rates will be kept in place for an “extended period.”

Hoenig’s understandable view, in my paraphrase:  the economy is recovering, if slowly, so why use language that would seem to lock you into a longish-term commitment to emergency low rates?

Take away that “extended period” language and you would let people know that at some point you will return to merely easy monetary policy.

But the rest of the FOMC voters see no reason to shut off Groundhog Day. After all, they said (again) that “inflation is likely to be subdued for some time.”

The Fed seems to have a pretty good read on the economy. Slightly better today than in mid-March but far from out of the woods. Today, the labor market is said to be “beginning to improve.” In March it was “stabilizing.”

“Housing starts have edged up but remain at a depressed level.” In March, “housing starts have been flat.” 

The key fact seems to be that “employers remain reluctant to add to payrolls,” in the words of the Fed. That hasn’t changed and will likely only change to the upside very slowly in the months ahead.

That crucial indicator, and its molasses-like improvement, will keep the Fed’s statement writers nearly idle for the next few meetings. Nothing much will need to be changed.

It was a banner day for market economists: Federal Reserve types were popping up and speaking everywhere.

We had past and present. Former Federal Reserve Chairman Alan Greenspan talked to the bipartisan panel trying to figure out the causes of the credit crisis. The ex-chief understandably defended his tenure and said high levels of reserves at financial institutions paved the way forward.

The current top central banker, Ben Bernanke, gave a stern warning about the need for a long-term plan to lower federal deficits, lest declining faith in the U.S. among investors push interest rates higher somewhere down the road.

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In the first dissent at a Federal Open Market Committee meeting in about a year, one of the voting members publicly wouldn’t go along with the crowd.

Thomas Hoenig, president of the Federal Reserve Bank of Kansas City, wouldn’t make it unanimous today to keep short rates at zero and tell the world they will continue to stay that way for an extended period.

Good for him. Though the Fed is unlikely to move on rates at all in 2010, the emergency conditions that required them to stand at zero have dissipated, regardless of how fragile the economic recovery remains.

As I’ve previously argued, big budget deficits, a stabilizing economy, and long-term inflation fears in some parts of the market mean the Fed should at least take the cost-free step of removing the “extended period” language on the slow walk away from zero short rates.

The Fed isn’t always clear in the language employed in the statement released after FOMC meetings, but in describing Hoenig’s decision, the language was reasonably to the point.

Hoenig “believed that economic and financial conditions had changed sufficiently that the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted.”