ALERT: Fed Considers ‘Sterilized’ Option for Future Bond Buying

A few days ago, the WSJ published an online half-page article, apparently released by the Fed indicating that the it may be about to launch a(nother) new scheme called “sterilized bond purchases”, In case the Fed announcement was too brief to be clear, here is (our take on) what the scheme would involve: (1) The Fed re-starts its QE bond-buying of Treasuries and mortgage securities (again, said to be targeting home mortgage rates). (2) The Fed prints more dollars (lots more??) with which it pays the sellers of those bonds (typically Fed-regulated banks) and then borrows them back at 1% interest, allegedly keeping all that newly printed money out of the economy. In theory, the Fed thus holds back a Red Sea of inflation, rising rates and bondholder capital losses, but it also further jacks up the present value of American corporate pension liabilities.

Early thoughts:

  1. The Fed has already printed an avalanche of money which has effectively prevented the bond markets from reacting to the US Government’s 4th straight trillion-dollar-plus budget deficit…but this series of Fed bailouts of the US Government (the bail-er) is uncomfortably like the political situation in Congress…. unsustainable (which the Fed knows).
  2. The sterilized bond buying scheme, if executed, will continue and deepen the policy-syndrome that artificially punishes savers, subsidizes borrowers and shields lenders from market forces.
  3. The Fed’s contemplated borrowing-back of the payments it makes to purchase bonds (mostly US Treasuries) is nothing more than indirect continuation of Fed-financing of US budget deficits, this time wrapped in a cute, novel device designed to fend off normal market reaction (rising interest rates); in the end, this Fed prop-up of abject Washington political failure will tend to dis-member much of the remaining free bond market, especially the deeply distressed cash-equivalent portion of it.
  4. The Bottom Line is a question: Will the developed nations’ banking institutions and, hence their economies, simply take-off from the foamed runway constructed by the US Fed, or will $3 Trillion of new US Dollars (in less than 4 years) eventually turn out to poison the world’s economic digestive tract, via soaring commodities prices? Clues to watch: the prices of oil and gold.

The Fed’s scheme would also directly tilt national elections in the favor of incumbents in both political parties who, without the Fed, would likely suffer deep turnover at the polls in November. From their curious perspective, that turnover would create “disorder”.

Viewed from the bottom up, this scheme apparently tells us that the Fed: (a) remains really worried about its lonely role, foisted by the US Congress and the President and (b) is reacting to the chorus of criticism about what it has been doing, with no prospect of an un-doing.