Download Hunt Chapters 9, 10

Chapter Nine: The Personality
of the Fed
Ipek Kazan
Raegen Richard
Jon Greenwald
The Federal Reserve
• Regulates nation’s money supply
• The only American institution with the
ability to create money
• Interacts with the federal government and
international policymakers.
• U.S. Economy: Family
Fed: The Head of the family
The Personality Of The Fed
• The personality of the Fed reflects the
personality of its chairman
• How to get to know the Fed?
- Get to know its chairman
- Learn to listen to the Fed’s public statements
- Watch Fed’s daily operations
- Pay attention to Fed’s attitudes (anti-inflation
and pro-growth)
- Watch how the Fed handles stress
Understanding The Chairman’s
Activities
• Examine the economic goals of the
president
• Watch the foreign exchange market’s
treatment of the dollar
• Consider chairman’s professional
background
The Chairman’s Job
• 2 Main goals: low inflation and modest but
consistent economic growth
• Enough money to keep economy growing
• Prevent excessive inflationary intoxication
• Walk the line between economically sound
and politically expedient
Public Statements
• Discount rate statements
– Whenever discount rate changes, the Fed issues a
statement.
• Federal Open Market Committee Meeting
Minutes
– Published in Federal Reserve Bulletin
• Humphrey-Hawkins Reports
– Chairman addresses Congress in February and July.
– Reports are televised on C-SPAN and analyzed in
major newspapers.
Body Language (Daily Market
Operations)
Look at daily market operations
Purchase or sale of U.S. Government securities
• Typically done between 11:40-11:45 A.M.
• Thursday operations important:
- The first day of the bank statement week
- Fed can maximize its impact on reserves
Changing Attitudes can occur
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Dire inflationary trend
Deep economic recession
Foreign exchange crisis
Domestic financial crisis
New Fed Chairman takes office
Fall of 1979
• Monetarist Approach to Central Bank
management
– Monitoring and regulating money supply
became main concern
– Tight monetary policy caused deep recession
of 1981 and 1982
– Curbed high interest rates and rapid inflation
of late 70’s and early 80’s
Crisis Investing
• When major corporate bankruptcies occur
– Fed is lender of last resort to maintain
efficiency
• Investments perform well during this time
• Penn Central Bankruptcy
– $82 million outstanding as commercial paper
– Occurred on border of Ease-Off and Plunge
phases
Crisis Investing Con’t.
• Penn Central Con’t.
– Optimal Investment Response
• Take position in stocks and bonds
– Bankruptcy and GM strike pushed economy
into the Plunge phase
– Created major bull markets for stocks and bonds
• Yields on ten-year Treasury Notes fell over 50
basis points (favorable)
• NYSE index rose 13.4 percent
Crisis Investing Con’t.
• Franklin National Bank Insolvency (1974)
– Fed lent whatever was necessary to pay off
maturing deposits (totaled $1.7 billion)
• Problem occurred between Ease-Off and
Plunge
– Optimal Investment Response
• Take position in stocks and bonds
– Yield on ten-year Treasury Notes fell 100
basis points
Crisis Investing Con’t.
• Hunt Silver Crisis
– Silver collapsed and interest rates increased
• Defaulted on margin calls on the Comex
– Occurred in the middle of a minirecession
– Optimal Investment Response
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Extend maturities on bond investments
Move to financial instruments
Yield on ten-year Treasury Notes fell 350 basis points
S&P rose 10 percent
Gold didn’t do so well
Crisis Investing Con’t.
• Lombard Wall-Drysdale Double Crisis
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–
–
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Both went bankrupt
Large investment positions with small capital bases
Occurred during Plunge phase of 1982
Optimal Investment Response
• Increase investments in longer term debt instruments and
stocks
– Ten-year Treasury Note dropped 300 basis points
– S&P index rose over 35 percent
How To Respond
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Do not panic
Go for quality
Reassess your big picture
Investment reaction should relate to the
phase of the cycle where the crisis occurs
Crises In The Future
• Why Crises lie ahead
– Frequency and severity of inflationary cycles
• Due to more speculative habits
– Banking system not as solid as it used to be
• More loans to high risk creditors
Chapter Ten: Two Well-Known Interest
Rates and How They Work
A Tale of Two Over-rated Rates
• The Federal Reserve Discount Rate
– A bank’s cost to borrow reserve funds directly from
the Fed’s Window
• The Federal Funds Rate
– A bank’s cost to borrow reserve funds from another
bank in the system
• “…both the discount rate and the Federal funds rate are
valuable BUT NOT crucial to reading the Fed and
responding with a sound investment strategy. The real
answer lies in the monetary base, the basic money
supply and velocity which I explain in the next two
chapters.” (emphasis added)
The Discount Rate
• Deceiving and Perceiving
– Media Hype
– The discount rate does not directly steer the
economy or interest rates
• Changes in the discount rate do affect the
economy and interest rates, but there are
many other significant elements in play
Three Varieties of Rate Changes
1. Leading
– Discount rate cut causes a decline in interest
rates and economic stimulation
• May 1985 cut led to a 14% decline in Treasury yields
and an 18% increase in the DJIA by year’s end
2. Lagging
– The Fed may use the discount rate to support
monetary tightening or easing
• December of 1982: markets saw a seventh consecutive
rate cut as unnecessary because economic recovery
was well underway and other rates actually rose in
early 1983
Three Varieties of Rate Changes
3. Missteps
– The Fed may take a series of increases or
decreases too far and then need to reverse
suddenly
• July of 1980: cut from 11% to 10%. Concurrently,
increases in interest rates, the money supply, inflation,
and the economy continued. In September the Fed had
to return the discount rate to 11%.
Three Varieties of Rate Changes
What do you see?
• Examine the statement that
accompanies the change
– The Fed may say it is trying to bring
the discount rate in line with the
market.
• Watch the response of other
rates
– There may be abiding interest rate
moves in the same direction
• Observe the momentum of the
overall economy
– Discount rate changes are effective
at dampening and stimulating
• The Fed’s discount rate changes
often lag other indicators and are
preceded by missteps
The Federal Funds Rate
• The Fed funds rate is not a good leading
indicator of monetary policy
– Many factors outside of the Fed’s control can
impact the rate
• It is a good indicator of where monetary policy
stands
– The Fed can influence through its supply of
reserves
• Look at weekly or monthly averages and
analyze to see if there is movement away from
a trend
THIS IS THE END
THANK YOU FOR YOUR ATTENTION