The release of the minutes from the last Federal Reserve meeting, which took place on June 19 and 20, came with some interesting items that weren’t mentioned at all. The financial crisis around the world is continuing to worsen, and investors were hoping that the Federal Reserve would indicate that additional monetary stimulus policy would be forthcoming any day now. This was not to be. While several members of the Federal Reserve indicated that additional monetary stimulus was warranted, the majority of the Federal Reserve members were more cautious and decided to take a wait-and-see approach.
The economic data from Europe and emerging markets, such as China, are getting worse, and investors are becoming increasingly worried that the financial crisis will spread to American shores. I think we’re already seeing the possibility of a financial crisis erupting, as economic data in America continues to decline at an accelerating rate. This includes economic data of manufacturing firms, which are becoming more pessimistic as that sector weakens, and the quarterly earnings releases in which companies are issuing negative guidance for the next several quarters.
The latest minutes from the Federal Reserve do show that an increased number of participants acknowledged that the risks to the economy were to the downside, with 15 members stating this viewpoint in June compared to only eight in April. As well, 13 members declared that the unemployment rate has a chance of moving higher, as opposed to only nine in the April Federal Reserve meeting. There are 19 Federal Reserve presidents and governors at each meeting, with 12 who vote directly on policy decisions.
An interesting twist in this latest Federal Reserve meeting is the mention of additional tools for financial stimulus that are new and outside the traditional sphere of policy action. To me, this indicates that Federal Reserve members are worried about a financial crisis but are looking for new ways to alleviate the pressure without running out of ammunition.
As in many things in life, there is a law of diminishing returns when it comes to monetary policy. With the massive amounts of stimulus already enacted by the Federal Reserve in reaction to the financial crisis of 2008, we see now that the results have been far less than expected. Each subsequent monetary policy move has been met with a diminished return in the markets and economy. The latest such examples were the recent moves by the People’s Bank of China, the European Central Bank (ECB), and the Bank of England (BOE), each of which added additional easing measures in their respective monetary policy stance, which had a net positive effect in the markets for basically one day.
I believe the Federal Reserve realizes the limitations of additional monetary policy and is reserving said initiatives for a true financial crisis or shock to the system. I think that the Federal Reserve believes there is a possibility of a shock to the system, such as one of the European nations leaving, the euro breaking up completely, perhaps China crashing hard, or some unforeseen event, which will hit America extremely hard and push us into a financial crisis situation.
On top of that, I believe that the Federal Reserve is counting on the additional monetary stimulus from both Europe and Asia to help America’s problems. If those regions of the world were to begin growing economically again, this would be a positive for America. This would also alleviate some of the need for the Federal Reserve to enact further policy moves before a one-time financial crisis hits. Personally, I’m not sure if there’s time to wait for other nations to enact such initiatives, as I see further weakening in the U.S. economy over the short term. Time will tell what the Federal Reserve will do, but I would caution investors who are betting solely on additional monetary stimulus that it might be further away than they think.