FED | Getting Ready to Start to Crunch.

Janet Yellen, Chair of the Federal Reserve Board.

When the Fed starts to crunch, it's time to go to lunch.

The FOMC meets next week. There is talk of moving out of the zero-bound zone. Scary.

Especially when it's been nearly seven years since the 2008 meltdown and there are young people on Wall Street who have never lived through such a crisis.

As Bernard Shaw said: "We learn from history that we learn nothing from history."

Federal Reserve Bank of New York William Dudley's understated ruminations about financial market challenges ahead ahead are being echoed more loudly and nervously elsewhere by comments and stories from:

• Richard Berner of the Office of Financial Research at the Treasury
• Bloomberg News
• Pam and Russ Martens at Wall Street on Parade  

The rest of this post provides a summary of the difficult options facing the Fed and the implications for financial markets by Risk Management Advisors LLC in their June Chartbook. I am grateful to Noralyn Marshall for sending this to me and for allowing me to excerpt here from her chart book.

The zero-bound interest-rate policy that the Fed has pursued and other central banks have echoed has helped in the seven years since 2008 to restore some financial stability, at the expense of huge debt and a loss of the usual tools of monetary policy.

Risk Management Advisors sums up the perilous situation as one dominated by global central bank policy. We know that

• Risk assessment has been distorted by a sea of liquidity and very low policy rates. The reach for yield has favored weaker credits, longer durations, and equities.
• Debt is higher than it would have been under normal conditions, despite knowing that the great recession was the result of a debt-fueled bubble.
• Some people have assumed debt based on excessively optimistic interest rate assumptions.
• Credit has been granted by those with little experience in evaluating and managing credit risk (crowd funding for example).
• Volatility-based measures of risk are understating future volatility when the Fed no longer dampens it.
• Boosting financial assets has widened the wealth gap. 
• The major economies all face fiscal constraints. [And so do state and local governments.]
• Central bank purchases have temporarily removed market risk from government financing and dramatically lowered its cost.

What we don’t know is how central banks in the US, Japan, EMU, and the UK will navigate out of their iron grip on markets and bloated balance sheets.

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