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Paul Vangilder

The Federal Reserve. Paul Vangilder. History. Created on December 23, 1913 in response to a century of banking panics Lender of Last Resort Dual Mandate Maximum Employment Price Stability Recently assumed increased regulatory duties. Structure. 13 Regional Fed Banks

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Paul Vangilder

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  1. The Federal Reserve Paul Vangilder

  2. History • Created on December 23, 1913 in response to a century of banking panics • Lender of Last Resort • Dual Mandate • Maximum Employment • Price Stability • Recently assumed increased regulatory duties

  3. Structure • 13 Regional Fed Banks • Headquartered in DC • New York Fed • Largest and most influential bank • Conducts open market operations • Vault holds 216 million troy ounces of gold

  4. Monetary Policy • 3 Main Tools • Reserve Requirement • Proportion of demand deposits a bank must hold on reserve at Fed • Lower Reserve Requirement: Stimulative • Allows banks to make more loans • Raise Reserve Requirement • Banks forced to keep more on reserve at Fed • Leads to less loans • Discount Window • Short-term, secured lending facility that banks can borrow from • Raise Rate-Contractionary Policy • Lower Rate-Stimulative • Open Market Operations

  5. Open Market Operations • FOMC Committee determines Open Market Operations • Chairman Ben Bernanke and 9 other Members • Eight meetings per year • Announcements on policy highly anticipated by Wall Street • Fed Buys short-term government bonds • Stimulative • Lowers interest rates • Increases money supply • Fed Sells short-term government bonds • Contractionary • Raises interest rates • Decreases money supply MSU Student Investment Association

  6. Open Market Operations • Fed Funds Rate • Overnight lending between banks • Currently 0-0.25%, intended to “stimulate” economy • Recently Announced it will be 0% through 2014 • Buy short-term bonds to lower rate • Increases liquidity in banking system • Sells short-term bonds to raise Fed Funds rate • Decreases liquidity • Large Scale Asset Purchases (QE) beginning 2008 • Fed buys long-term government bonds as opposed to just short-term

  7. Historical Fed Funds Rate

  8. Quantitative Easing • QE1 November 2008 to Spring 2010 • Fed Purchased: • $125 Billion in Agency Debt (Fannie/Freddie and Treasuries) • $1.25 Trillion in Mortgage Backed Securities (MBS) • Objective: Stimulate the economy, lower interest rates, and fight deflation • Shadow Objectives • Support solvency of the banking system • Devalue the dollar to boost exports • Drove stock market rally from March ‘09 to April ‘10

  9. QE2 • Summer 2010 • S&P 500 down 10% • GDP Growth Sub 2% • Fears of “Deflation” resurface • Bernanke informally announces QE2 at August 2010 Jackson Hole Speech • QE2 Formally begins November 2010 • To last through June 2011 • Fed purchased 4-6 billion in US Treasury securities per day • $600 Billion in total • 100% monetization of debt issuance from the Treasury

  10. QE’s effect on Markets • S&P 500 rises from 666 to over 1200 during QE1 • S&P 500 rises to multi year highs of 1,363 during QE2 • Inflation Rises • Oil up to $135/barrel in April 2011 • Gold Reaches all-time highs • Tremendous pressure on emerging market inflation

  11. Fed Balance Sheet vs S&P 500

  12. Operation Twist • Shift Duration of Fed’s Treasury portfolio • Fed will sell $400 Billion in 0-3 Treasuries • Buy $400 Billion in 6-30 Treasuries • Designed to lower long-term interest rates

  13. “Bernanke Put” • Put Option • Contract that insures an investor against loss • Derived from “Greenspan Put” • Fed Chairman 1986-2006 • Met every distress in financial markets with lower interest rates and more liquidity • QE provides temporary relief to structural economic problems • Pattern: • Economic problems resurface shortly after QE ends • Seen in Summer 2010 and August-September 2011

  14. Fed and Volatility • August 2011 Fed Meeting-No QE3 • Dow down 200 points immediately • Rallied over 600 points to finish up over 4%

  15. QE3? • Key metrics to watch to provide political will for QE3 • S&P 500~sub 1100 • WTI Crude oil~sub $80 • EUR/USD continues to fall • Dollar strength not good for short-term exports • Structure of QE3 • Bill Gross: $600 Billion of MBS Purchases • Others: Nominal GDP Targeting

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