Fed funds futures, widows, and orphans

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and anticipates that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.

The last thing Fed Chairman and Great Depression scholar Ben Bernanke wants to do is “abort the recovery by premature tightening,” which is what his predecessors did in 1936 and 1937, says Paul Kasriel, chief economist at the Northern Trust Corp. in Chicago. “At what other time has a 345,000 job loss been a reason to celebrate?”

Kasriel thinks it will take until mid-2010 for Bernanke to have confidence that the recovery is for real. Most economists, unlike traders, are saying later rather than sooner.
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Maybe the reaction is just a bad case of jitters over the existence and execution of the Fed’s exit strategy. It’s true that the Fed’s balance sheet will show some natural attrition as financial institutions resume their traditional lending function and the Fed imposes a penalty for using its various lending facilities. (In the old days it was considered a privilege, not a right, to borrow from the Fed’s discount window.)

Fed officials talk exit strategy in the same breath they reassure the markets to expect an “exceptionally low” funds rate “for an extended period.”

Instead of turning up the volume on “exceptionally low” in an effort to soothe the market, the Fed should try to be exceptionally explicit on what the egress will look like: Whether it will focus on the excess reserves banks are currently holding, which have the potential to multiply and become inflationary, or on the good old-fashioned funds rate.

Then there are the financial experts in Congress. While grilling Bernanke won’t be as much fun as playing pinata with bank CEOs, House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Chris Dodd will surely offer him some exit guidelines, especially if the unemployment rate -- up 4 percentage points in the past year to 9.4 percent -- crosses the 10 percent threshold.

After all, they have to look out for the real widows and orphans.