The Ides Have It

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Foreign purchases of U.S. securities fell in January as overseas investors sought to diversify their holdings. However, purchases of U.S. treasuries held up fairly well. China, the largest holder of U.S. treasuries, reduced its holdings of U.S. treasuries by $5.4 billion to $1.15 trillion. Japan, the second largest holder of U.S. treasuries, increased its holdings of U.S. by $3.6 billion to $885.9 billion. It should be noted that this data is from January and does not include the very strong treasury auctions (including a record 10-year note auction) which occurred in February. Some market participants have expressed concerns that Japanese insurers could sell some of their U.S. treasury holdings to pay claims.



The market is taking that possibility in stride as the U.S. dollar and U.S. treasuries remain the world’s safe haven in times of turmoil. Also, approximately 93% of Japan’s government debt is held by Japanese investors, including Japanese institutions. It is just as possible that institutions sell Japanese debt to pay for claims.


When Fed governor Kevin Warsh vacates his post later this month, he will be the latest of Fed Chairman Ben Bernanke’s so-called “inner circle” to leave the Fed. However, Mr. Warsh expressed concerns that implementing QE2 came with possible unintended consequences. This caused Fed watchers to wonder if the relationship between Mr. Warsh and Mr. Bernanke were irreparably damaged. Mr. Warsh’s departure follows those of former vice chairman Donald Kohn and former New York Fed president Timothy Geithner, who left to become treasury secretary. In their place are former San Francisco Fed president Janet Yellen, who is taking over as vice chairwoman and current New York Fed president William Dudley. Both Ms. Yellen and Mr. Dudley supported QE2 and are considered to be dovish with regards to inflation.



The New York Fed is considered to be the most influential of the regional Fed banks. This gives the accommodative Mr. Dudley a relatively loud voice with regards to Fed policy. As vice chairwomen, Ms. Yellen can be expected to have the ear of chairman Bernanke. Some believe that the new makeup of the Fed makes it more likely that the Fed will follow through with its QE2 purchases and be very cautious when considering raising the Fed Funds rate.



Inflationary concerns have been lessened during the past four trading sessions as the earthquake in Japan and the resulting nuclear problems have market participants concerned that Japan’s economy will be impaired by the disaster, reducing the demand for energy products and raw materials (although Keynesians may be of the opposite opinion, Toyota, Nissan and Honda have shut down assembly lines in Japan which is not good for the Japanese economy). Crude oil is down $2.61 today to $98.58. Of course it could be that speculators are taking some of their profits off the table.



If there is a lesson to take away from recent market performances, it is that we should expect the unexpected. The question remains about whether or not the economic recovery is strong enough to withstand disruptive global events. Whether or not it can remains to be seen, but one would probably get few arguments if one opined that the recovery would not be able to withstand recent events if the Fed had already begun to remove stimulus.

No surprises from the FOMC today. As expected, the Fed Funds rate remains at 0.00% - 0.25% and the Fed remains committed to following through on QE2. The FOMC language was cautiously optimistic, also as expected. Here is a copy of the FOMC text:



Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually.

Household spending and business investment in equipment and software continue to expand. However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Commodity prices have risen significantly since the summer, and concerns about global supplies of crude oil have contributed to a sharp run-up in oil prices in recent weeks. Nonetheless, longer- term inflation expectations have remained stable, and measures of underlying inflation have been subdued.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability.

Currently, the unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate. The Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization. subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.







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