Dudley as Avatar of Quantitative Ease Predicts Credit Creation
Among dozens of public appearances by Federal Reserve officials between their last two meetings, one stands out: New York Fed President William Dudley’s Oct. 1 speech that more monetary stimulus likely was needed to combat “unacceptable” inflation and unemployment.
The message from Dudley, vice chairman of the policy- setting Federal Open Market Committee, was echoed three days later by the New York Fed markets-group chief, Brian Sack, who said further expansion of the central bank’s balance sheet would foster growth. They telegraphed to the market that more easing was coming, even as five other Fed officials articulated their opposition. On Nov. 3, the FOMC announced it would buy $600 billion in Treasuries in an unprecedented second round of unconventional easing.
“The speeches by President Dudley and Brian Sack were the first clear indications from the Fed that this was quite likely to happen,” said Dean Maki, chief U.S. economist at Barclays Capital Inc. in New York. “Those speeches came out shortly after the September meeting and made it sound like it was unlikely the data would change the Fed’s mind.”
Dudley’s remarks provided a road map for the FOMC’s ultimate decision, underscoring the importance of paying attention to what he says, according to John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina.
“I’ve known Bill for 25 years, and he’s a very responsible person who’s not going to go willy-nilly,” Silvia said. “Dudley pretty much reflects the philosophical view” of Fed Chairman Ben S. Bernanke, and “in today’s environment, the head of the New York Fed is not going to go out there and throw out arbitrary statements that are not going to happen.”
Dudley, arguably the most dovish policy maker on the FOMC, used this and other speeches to increase market expectations for quantitative easing and accelerate its impact, said Dino Kos, managing director at Portales Partners LLC in New York and a former executive vice president and markets-group head at the New York Fed.
Bernanke opened the door for further monetary easing in a speech at the Kansas City Fed’s annual symposium in Jackson Hole, Wyoming, on Aug. 27, saying the central bank would “do all that it can” to ensure a continuation of the economic recovery, and more securities purchases might be warranted if growth were to slow. On Oct. 15, he said “there would appear, all else being equal, to be a case for further action” because inflation was too low and unemployment, which has stalled at or above 9.5 percent since August 2009, was too high.
‘Drown Out’ Hawks
The presentations were made “to drown out the hawks” and “achieve an easing of financial conditions immediately, before the first security was purchased, indeed even before the announcement was made,” Kos said. Krishna Guha, spokesman for the New York Fed, declined to comment.
The average rate on a typical U.S. fixed-rate 30-year mortgage dropped to 4.2 percent on Nov. 8 from 4.47 percent Sept. 30, according to data compiled by Bankrate.com. The Standard & Poor’s 500 Index of stocks returned 7.4 percent through Nov. 8.
JPMorgan Chase & Co. economists last week increased their current-quarter growth forecasts for both the U.S. and Europe by 0.5 percentage point to 2.5 percent and 1.5 percent, respectively, partly because the “strong policy-commitment signal coming from the Federal Reserve” has improved financial conditions, according to a Nov. 4 report.
The New York Fed president is the only regional reserve bank chief with a permanent vote on the FOMC, and thus the position has always carried more power than its counterparts. Dudley’s view may be particularly important now, as the central bank turns to unconventional tools after leaving its benchmark rate near zero since 2008, entering what Cleveland Fed President Sandra Pianalto called “uncharted waters” and sparking disagreements about the course of action.
The Fed’s communications “could have been better, but they didn’t really have any framework or roadwork” to rely on, said John Lonski, chief economist at Moody’s Capital Markets Group in New York. “Another characteristic of the Bernanke Fed is that it tends to be largely based on consensus” and debate is encouraged, he said. “That may hinder the Fed’s ability to act swiftly and communicate its intentions clearly.”
Top U.S. Economist
Dudley, 57, who succeeded Timothy Geithner as president of the New York Fed in 2009, holds an economics doctorate from the University of California at Berkeley and worked as a Fed economist from 1981 to 1983. He joined Goldman Sachs Group Inc. in 1986 and became the top U.S. economist there, then moved to the New York Fed in 2007.
His Oct. 1 speech set market expectations for the central bank to buy at least $500 billion of bonds because he said purchases totaling about that amount would add as much stimulus as lowering the Fed’s benchmark rate between 0.5 percentage point and 0.75 percentage point. Sack three days later explained that a second round would merit a different strategy and more “flexibility” than the central bank’s earlier purchases of $1.7 trillion in securities at the height of the credit crisis.
The Fed said last week it will buy about $75 billion of Treasuries a month through June. The central bank will “regularly review” the pace and total amount of purchases and “will adjust the program as needed,” according to the FOMC’s statement.
The new stimulus is the opposite of the exit strategy investors were predicting after the U.S. economy grew 5 percent in the fourth quarter and another 3.7 percent in the first three months of 2010. Meanwhile, Dudley hinted he wasn’t satisfied with the pace of the recovery.
On May 21, about two weeks after the Fed restarted emergency currency-swap lines with foreign central banks to help stabilize the European debt crisis, Dudley spoke at his alma mater, the New College of Florida in Sarasota. U.S. growth was likely to be “more sluggish” than desired, because consumers were cutting debt, banks remained under “significant stress” and temporary sources of growth, including President Barack Obama’s $787 billion fiscal-stimulus programs, were expiring, he said.
Two months later, on July 22, Dudley said in New York that the “road to recovery is turning out to be a bit bumpy” because of weak consumer spending and financial-market “problems.”
Source of Growth
He also flagged that the economy may lose inventory restocking as a source of growth, after the Commerce Department reported July 14 that stockpiles rose 0.1 percent in May, a sign companies were preparing for weaker sales.
In August, the central bank surprised investors by announcing it would keep its holdings of domestic securities unchanged at about $2.05 trillion by reinvesting proceeds from mortgage debt into Treasuries, putting the exit on hold. At its next meeting, on Sept. 21, the FOMC said it was prepared to ease policy “if needed” to spur growth and achieve its dual mandate of stable prices and full employment.
Ten days after that policy session, Dudley said “further action is likely to be warranted unless the economic outlook evolves in a way that makes me more confident.” Restarting purchases of Treasury securities would reduce borrowing costs and support the value of homes and stocks, making housing and the cost of capital for businesses more affordable, he said in New York in the Oct. 1 speech.
‘Threshold for Action’
“What Dudley said was, ‘We should do more even if nothing changes,’” Kos said. “The threshold for action had changed. Deterioration wasn’t necessary. Lack of improvement was enough to trigger action.”
It was “highly unlikely” Dudley would have been so explicit without Bernanke’s backing, Goldman Sachs economists said in a report at the time.
Dudley reiterated his view that action was probably needed on four other occasions last month, including during a trip through upstate New York. He said that the levels of unemployment and inflation were “unacceptable” on Oct. 25 in Ithaca, New York, after a guest lecture at Cornell University and a visit to Kionix Inc., which makes high-performance inertial sensors. He repeated that message on Oct. 26 in Rochester and on Oct. 27 in Buffalo after touring a General Motors Co. engine plant.
The speeches overshadowed opposition from Dallas Fed President Richard Fisher, the Philadelphia Fed’s Charles Plosser, Narayana Kocherlakota of Minneapolis, the Richmond Fed’s Jeffrey Lacker and Kansas City Fed President Thomas Hoenig. Only Hoenig has a vote this year on the FOMC, and he has dissented seven consecutive times.
Dudley “broadcast the Fed’s intentions loud and clear,” said Moody’s Lonski. “They’re basically pouring a little bit of lighter fluid on an economy that is beginning to perhaps catch fire.”
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