No Fed Bill Issuance

Three months ago, at a joint press conference the Federal Reserve and Treasury indicated they would seek Congressional authority for the central bank to issue its own bills. It appears to have run into a political buzz saw and contacts report Fed and Treasury officials have backed off. Contacts had suggested as much a couple of weeks ago, but press reports now lend greater credence to what we had heard.

In testimony last week, Bernanke did not cite issuance of its own bills as a means by which the Fed could absorb and manage liquidity. He placed greater emphasis on Fed's ability to pay interest on bank reserves.

To be sure Fed officials would still like the authority. NY Fed President Dudley was quoted last week indicated that the while the Fed would like Congress to consider granting the authority (though no formal request appears to have been made); but it was "nice to have--as opposed to critical."

The political mood is such, contacts on the Hill report, that Congress is seeking to reassert its authority, given the large discretion that the Fed and Treasury have had during the crisis. The Fed's powers is a Pandora's Box and once opened, it is difficult to tell where it will lead. There are some who what to add to the Fed's dual mandate of price stability and full employment a third objective--prevent the emergence of asset bubbles. Others want to give the Fed a formal inflation target. At the start of Q2, the Senate passed a non-binding resolution calling on the Fed to identify the borrowers of its different facilities

Yet another resolution wanted to re-examine the number of Fed banks. One member of the House of Representatives suggested that regional Fed presidents should be confirmed by the Senate. Presently, Fed presidents are nominated by their banks' board of directors and approved by the President-nominated and Senate confirmed Fed governors.

Congress seems very reluctant to give the Fed greater independence. Currently Congress limited debt issuance by the Treasury Dept, at least nominally. If the Fed would issue its own bills, would Congress try to cap issuance or would this interfere with the tactical needs of the central bank. Would the Fed's bill issuance compete with Treasury's bill issuance.

When Congress authorized the Fed to pay interest on bank reserves, it also insisted that the Fed provide some relief to the mortgages that it was acquiring. Congress also required the Fed to report to it on the emergency actions.

Although we felt strongly that the market was getting ahead of itself insofar as the Fed funds futures were pricing in a tightening move by the end of the year, we do think that with banks paying back TARP, several other Fed programs winding down (because of their success), the continued turning of second derivatives (pace of contraction slowing), and some leading indicators, such as new orders (ISM mfg), and increasing normalization of the capital markets, the focus on officials and market participants will likely increasing turn to exit strategies.