Fed to twist in September

A variety of financial market indicators got materially worse last week (bank equity vol and CDS spreads, high yield spreads, etc) so it’s not really a surprise that the Fed is telling their unofficial mouth-pieces that it’s basically made up its mind to lean against these headwinds at their September meeting.

Both the WSJ’s Hilsenrath and the FT’s Harding have written substantially the same story – that the FOMC is likely to announce an extension of the duration of the SOMA portfolio following their September meeting.

The other two policy options – cutting the IOER rate, and tieing the funds rate pledge to economic conditions – seem too contentious for steps in those directions to be undertaken just yet.

For what it’s worth, I think it’s a bad idea to cut the IOER rate just now. The positive spread between the fed funds rate and the IOER rate is like a small subsidy for banks, and that’s working to add to their capital base.

I think that’s a good aim for policy just now. Capital is the issue.

As it happens, it’s also the solution to this European mess – their banks must raise more capital so markets will trust them once again.

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