Benchmarking The Fed

Fed chair Bernanke spoke at the central bankers' annual confab in
Jackson Hole, WY yesterday. He promised further accomodative
action by the Fed should the recovery falter and should the US find
itself facing an episode of price deflation. Easiest way for the Fed to
help out is via purchase of additional financial assets. Time to
benchmark where the US is.

Business sales --retail,wholesale and mfg. -- were up over 9% yr/yr
through June. Monthly demand data including retail sales and
industrial production were up nicely in July to cap off a solid month.
As discussed earlier this week, there has been no positive inventory
cycle swing to speak of and construction remains in the dumper.
Given the large fiscal and monetary stimulus available over 2009 -
2010 ytd, the recovery should have been stronger, but it was solid
enough. Caution by households, business and the banks over the past
year have put a damper on the power of the economy, no doubt
about that.

Weekly economic data so far in August suggest the economy is now
leveling off, as signaled earlier in the year by the leading indicators.
Moreover, monetary liquidity is dissipating and broad credit driven
liquidity is relatively flat. Continuation of the deterioration of the
liquidity environment would point toward development of another
recession in 2011 if the liquidity freeze proceeds through the end of
this year.

Bernanke expressed considerable reluctance to add more liquidity to
the system without further deterioration of the economy. Logically,
this means the economy will be more dependent on rising credit
demand and the willingness of bankers to service it as we go forward.
If such does not materialize, then the economy should eventually
deteriorate and the Fed's hand will be forced. The risk here is that
private sector confidence may decline enough in a newly deterior-
ating economic environment, that further monetary easing may be of
only marginal positive significance.

It could take until the end of 2010 for this drama to play out. since I
have never seen a situation quite like this one before, I am 100% in
cash for the time being, with a short of the long Treasury all that is
on my radar as a possibility for now.
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Since the Fed more than doubled the size of its balance sheet as well
the monetary base over the past 18 months, the central bank needs
some leeway to see how the fruits of its labors develop. As well, it is
clear that some of the governors of the Board appear very reluctant
to add further liquidity as there is considerable and reasonable concern
about how to manage the excess reserves if the economy proves
stronger than now anticipated. I doubt Bernanke sees this concern as
a cause for inaction, but he has some fire breathers to contend with.

Speaking of politics, the Obama administration seems to be wimping
out on the issue of a decelerating economy. Perhaps sly old Larry
Summers has some positive numbers up his sleeve, but if not, then
time may be of the essence to stand up and say the Gov't needs to
do more. Better to have fought and lost than not to fight and lose
anyway.