Market Mover - BNP PARIBAS - Investment Services India

and that “in the long run, the Federal Reserve
anticipates that its balance sheet will shrink toward
more historically normal levels and that most or all of
its security holdings will be Treasury securities”. The
Fed would consider selling securities only in a robust
macroeconomic scenario, and “any such sales would
be at a gradual pace, would be clearly communicated
to market participants, and would entail appropriate
consideration of economic conditions”. The clear
signal is that the Fed is comfortable living with an
expanded balance sheet for some time.
The testimony provides more detail about
sequencing and execution but does not change
our view of the likely timing of policy tightening
While some market participants view this clarity from
the Fed as a signal that such operations are on the
near-term horizon, we would stress that Chairman
Bernanke reiterated that the current stance of policy
has not changed and will be determined by economic
and financial market developments.
Indeed, it is difficult to see the Fed moving to raise
rates when bank lending is still contracting (Chart 2).
Small and mid-size banks continue to fail; the FDIC
took over 148 institutions in 2009 and has already
taken on 16 in 2010. This suggests an ongoing
consolidation process from the financial crisis that is
limiting credit supply.
However, there is also a significant demand element;
the broad economy is still deleveraging and this has
been manifested in a subdued recovery in final sales
to date (Chart 3 and 4). It would seem that some
recovery in private credit creation would likely come
before the Fed decided that the economy was
building up too much steam and needed to be
restrained. Rather, we view this as an indication of
the extraordinary complexity and uncertainty in
orchestrating policy tightening in these unusual
circumstances and a desire by the Fed to develop
and communicate a robust toolkit well in advance.
Julia Coronado 12 February 2010
Market Mover
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