The Gloves Come Out Again

Fed Chairman Bernanke surprised almost everyone yesterday by not tapering, even a little. The pace at which the Fed is currently supporting the US economy, by printing money to buy bonds and thereby lower interest rates (so-called quantitative easing), at a rate of $85 billion a month, is to continue. This despite earlier Fed pronouncements, especially in June, when taper talk began, the result of which over the summer has been a dramatic tightening in financial markets. Yields on 10-year treasury bonds have risen by almost a full percentage point in America - the biggest one-time jump in decades - just on the prospect of the onset of tapering, and the effect has been global, with yields even in Europe rising and emerging-market currencies plunging.

The Fed cited growth that is less robust than it ought to be at this stage of the recovery, unemployment that although trending down is still too high (that is, above 6.5-7.0%), and underlying inflation pressures that are so tepid they could easily morph into deflation. So tapering, even a modest reduction to say $70-75 billion a month, must wait. A complete cessation of the program now seems months away, at least. Long bond rates dropped yesterday, and equity markets surged, as a result.

Apart from the weak data, however, the Fed was also concerned yesterday, arguably primarily, with another possibility, that is, a looming US federal government shutdown - another showdown between Congress, particularly the Republican House, and the Obama administration, over the debt ceiling. Seems the Fed concern was well-placed. The debt ceiling must be raised again, as it has been periodically for decades, by early next month, by Congressional legislation. If it isn't, the federal government technically defaults on its outstanding debt. (The delay in raising the debt ceiling in 2011 resulted in the first downgrade in the US credit rating, a sharp drop in the stock market, and an increase in borrowing costs.) President Obama has made clear in recent days that he will not negotiate the "technical necessity" of raising the level again. Republicans in the House, however, have a different view - Speaker Boehner announced today, tersely and bluntly, that America's debt level, now close to $17 trillion, or nearly 80% of GNP, must stop rising. The Speaker wondered aloud why the President would, for example, negotiate with Putin over Syria, but not with Congress over such a critical domestic economic concern. And to make the Republican position perfectly clear, Boehner has scheduled a vote for Friday on a bill that would condition a stopgap spending measure on support for de-funding ObamaCare. "We'll deliver a big victory in the House tomorrow and then this fight will move over to the Senate where it belongs," the Speaker said today. "I expect my Senate colleagues to be up for the battle."

So once again, the gloves are on and the tension ratchets up in Washington. Just as well that the Fed, responsible for monetary policy, but in recent years forced to be ever more mindful of Capital politics as well, decided to delay even the slightest bit of policy tightening.