November 22, 2010
By now, we all know about the decision. The media speculated wildly about the magnitude and outcome of this event. What was the potential impact? Who would be the winners and losers? Then afterwards, we saw the markets’ reaction, and not everyone was pleased, to be sure. The immediate impact was not what was expected, and certainly went contrary to pundits’ predictions. Still, the speculation is finally over, and this story will continue to make news through June of next year. But if you’ve been carefully watching this story play out, how could you not be impressed with last week’s performance? I mean, Chris Bosh had a season-high 35 points against Phoenix, and LeBron James and Dwayne Wade added 37 points and 15 assists between them in what is arguably their most complete game of the season thus far. Oh wait. Did you think I was talking about QE2 and asset purchases? About Chairman Bernanke and the FOMC decision? Well, surprisingly, there are quite a few similarities between the Miami Heat and monetary policy these days, and nothing short of a full NBA season is needed to see how both experiments play out.
As the Miami Heat goes, so goes QE2. Maybe that’s a bold statement. So is, “I’m taking my talents to South Beach,” or “The Committee intends to purchase a further $600 billion of longer-term Treasury securities.” Both statements elicited very strong reactions in the marketplace, with some voices of support and many more of condemnation, quite literally from around the world. Both statements were the culmination of overhyped media frenzy and were the subject of intense speculation leading up to their respective releases. To be sure, the Heat hardly made much of a statement with their opening game loss to the Boston Celtics, 80-88. As well, people are still scratching their heads and wondering why QE2 opened with a thud, and how 5-7yr treasury rates (the QE2 duration sweet spot) could be up more than 40 basis points since the Fed announcement, when purchases would be expected to drive rates down. Now the Heat and the Fed must move forward, with their decisions in the rear view mirror, and with the real work still lying ahead.
With a far-from-dominant record of 8-5 thus far, the Miami Heat have let a lot of air out of the pre-season “dream team” hype, but it’s far from flat. There are 82 games to play in a regular season, so they are really just getting started. Other teams in the league (and certainly their fans) are quick to point out that Miami is nothing more than it’s Big Three, and many doubt the eventual success of this team. But even the skeptics agree that if the Heat can click as a team, then they could go deep in the Playoffs. Still, anything short of a championship would be a let down to their fans. So too, the Federal Reserve has a lot riding on the success of QE2, and anything short of a tangible US economic recovery will be a let down to the American people. But just like with the Heat, the Fed’s asset purchasing season is just getting started, with average purchases of 75 billion in US Treasuries per month over the next eight months. And with the effects of monetary policy notoriously lagging implementation of policy by anywhere from 2 quarters to 2 years, we could easily see two NBA championships before we are able to judge the full impact of QE2. It will take patience on the part of fans in basketball and business to witness the building of a championship or a recovery.
Miami is hoping to deliver not only a championship, but a fervent set of new fans along the way. The Heat hope to build on the NBA’s broadening global appeal that was most visibly on display at the 2008 Beijing Olympics, when the NBA showcased its best talent (including Miami Heat trio Bosh, James, and Wade) before a world audience, and dominated with a gold medal performance. The Heat are hoping to export their brand and increase consumption of the games and the gear by a growing global fan base. But while Miami hopes to export a winning “image,” the US Federal Reserve is accused of exporting “inflation” to emerging markets already overheated with their own housing and asset bubbles in the making. Central Bankers around the globe are considering or already taking steps to keep excess US dollars out. Taiwan has recently expanded curbs on foreign investment in its debt, and China has placed new restrictions on foreign ownership of property, allowing foreigners to own only one property on the mainland. While basketball exports could be considered harmless (witness Allen Iverson’s export to Turkey!), excess dollars pose too big a risk for some countries.
So, with the NBA season underway, and with the Miami Heat playing every few days now, it is somewhat surprising to think that they still need to practice. They need to practice fully integrating all 15 players on the roster into the game, because the Big Three cannot do it alone. The team needs to work on its defense every bit as much as it focuses on its potent offense. So too, the Federal Reserve has a lot of practice in its future. Behind the policy hype and near daily open market operations to buy treasuries and expand liquidity, the Federal Reserve needs to practice its plan to reign in liquidity when the time comes to withdraw dollars from a recovering economy. Early on the Fed stood up a term deposit facility and reverse repurchase agreements to supplement its reserve deposit requirements as tools to implement monetary tightening. One of the greatest fears of those opposed to the Fed’s decision is that the Federal Reserve will not be able to mop up excess liquidity fast enough to prevent runaway inflation. It’s the constant testing and expansion of these and other facilities that the Fed must rely on to do just that. Only practice can make these facilities highly responsive and effective tools of monetary policy. When the regular season is over next spring, only a well practiced routine will sustain either program through the next round of play.
Whether you want to talk about bonds or basketball, we would welcome your call! While only time will tell how either program plays out, you can be sure that Chatham will give you sound advice on managing your business risks, time and time again.