I had breakfast Friday morning with Lena Komileva, the Group G7 Economist at Tullett Prebon. To get all Lunch With the FT about it, it was at the London Hotel, I had the scrambled eggs with smoked salmon, and she had an omelet with herbs, which I remember because she pronounced the “h” (she’s English).
Yes, it was a breakfast with somebody with an unwieldy, unprepossessing title from a firm you’ve never heard of. But Tullett Prebon is actually pretty interesting–a London-based “inter-dealer broker” that specializes in all sorts of weird and mostly incomprehensible derivatives and is doing a booming business in these turbulent times. And Komileva started off with a rapid-fire explanation of why the Fed shouldn’t cut rates Tuesday that left me slack-jawed in awe. She talked so fast that I never got around to pulling out a notebook and taking notes–it seemed pointless. But here’s my reconstruction-from-memory of her case:
There still isn’t conclusive evidence that the U.S. economy is headed for a recession. The negative August jobs number was due in large part to a cut in government payrolls that won’t repeat itself. So what the Fed is dealing with is still chiefly a financial-market problem, not an economic one. Plus the threat of inflation, the combating of which is supposed to be the Fed’s main job, is still very present with the price of oil hitting all-time highs.
A small cut in the Federal funds target wouldn’t do much to settle markets, since most people already have such a cut baked into their forecasts. A big cut might unsettle markets by driving the dollar further downward and raising both fears of inflation and worries that the Fed knows about some big problems to come that others don’t.
Also, to reassure markets in the case of a rate cut, the Federal Open Market Committee would probably feel obliged to accompany it with an optimistic statement implying disingenuously that further cuts might not be needed. If it left rates unchanged, on the other hand, the Fed could make clear that it remains very concerned and is willing to step in if necessary.
All this would free the Fed to focus on what Komileva thinks should be its highest priority: browbeating big banks and investment firms into sharply writing down the value of their mortgage portfolios. If all the banks cut the value of their mortgage books by 25%, and took the resulting hit to earnings, there would be a couple of horrible days on the stock market, followed by a slow, steady return to confidence.
So that’s the Komileva Plan. On Tuesday we’ll find out it it looks anything like the Bernanke Plan.
Update: In a note sent out to Tullett Prebon customers today, Komileva declared that she no longer harbors much hope that the Fed will do what she wants:
We now think that the Fed is likely to see the window of opportunity to implement more complex measures on Tuesday as small and will instead opt to bring the Fed fund target rate in line with the effective rate by cutting it by 25 bps, but signal that any further policy easing will be dependent on evidence in the economic data that the risks from tight conditions in money markets onto the real economy are beginning to materialize.