Play ball.So the head of the St. Louis Fed, William Pool, said the Fed won't do much for now. Just words. Just words. Let the cracks in the ice reach under some of the major consolidated merged financial mega-structures and then we will see the Fed twitch. Shortly, we will find what the rookie new fed chief Bernanke will do.
Fed won't ride to rescue of markets: Poole
By Greg Robb, MarketWatch
Last Update: 1:52 PM ET Jul 31, 2007
WASHINGTON (MarketWatch) - Financial markets understand that the Federal Reserve won't respond quickly to a typical market upset such as last week's sharp stock sell-off, St. Louis Fed President William Poole said Tuesday.
The Fed should only act "in due time" if evidence accumulates that the market drops could undo price stability or low unemployment, or when financial market developments threaten market processes themselves, Poole said.
Last week's cumulative drop was the worst in four years for the Dow Jones Industrial Average. At the same time, trading in credit markets and Treasurys led to concerns about a possible credit crunch. See Market Snapshot.
Analysts are now debating how the Fed will address the turmoil in its policy statement, to be released after its meeting next Tuesday.
In his speech, Poole said the best policy for the Fed is to be cautious and try to understand the reasons for the market turmoil.
If the Fed is "overactive" in responding to market developments, this would set precedents to destabilize markets in the future, he said.
"If the market believes that the Fed is always primed to adjust policy, then market participants will spend more time trying to second-guess the Fed than trying to understand what is happening to business and household behavior," Poole said in a speech prepared for delivery at the University of Missouri. Read the full text.
Poole said he was speaking only for himself, but his views add to the growing sense that the Fed under new chairman, Ben Bernanke, is trying to move away from the so-called "Greenspan Put."
That phrase was coined after Bernanke's predecessor, Alan Greenspan, pumped up the money supply in order to stabilize the markets after the stock crashes of 1987 and 1989, the demise of Long Term Capital Management in 1998, and the bursting of both the tech and the stock bubbles back in 2000. Read Kellner commentary on 'Greenspan put'
Poole said that his philosophy about the Fed's relationship with markets was grounded in the teachings of Milton Friedman.
But Poole said that well-anchored inflation expectations play a key role. This allows long-term rates to move in response to new information while short-term rates stay constant.
"The central bank can hold its policy rate relatively steady and rely on market adjustments in long rates to do much of the stabilization work," Poole said.
"When new information arrives, most of the time the central bank can wait for market responses and the passage of time to clarify what is happening," Poole said.
Poole said last week's volatile trading "was a perfect illustration" for the market. "The Fed doesn't know, and market participants do not know either, the full implications of last week's stock market declines and increases in risk spreads," Poole said.
"Market reactions last week may be overdone, or perhaps not," he said. "I'm not saying that the Fed should ignore what happened last week - we need to understand what is happening."
But Poole added that the Fed must not let uncertainty over policy to add to existing uncertainty.
"The market understands, I believe, that the Fed will act in due time if and when evidence accumulates that action would be appropriate," he said.
In some cases, like the terrorist attack of 9/11, a quick Fed policy response would be helpful, he said, but added that "a typical market upset, such as last week's, is not at all like 9/11."
Greg Robb is a senior reporter for MarketWatch in Washington.