Tagged: Fed

Who are you going to believe?

Compare and contrast –

Last night’s Fed Minutes from the Jan 27-28 meeting:

‘Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.’

Fed’s Williams interview from February 11th:

‘Here is my concern. You wait so long that you get behind the curve and then you have to raise rates really rapidly and that creates a lot of market turmoil and maybe even potential damage to the economic recovery. I would rather go gradually, thoughtfully in adjusting policy than waiting too long and having to catch up.’

Who are you going to believe? Which side will Yellen take in her semi-annual testimony? John Williams is the Governor at the San Fran Fed, the spiritual home of one J Yellen…. Could Janet want to use next week’s testimony as her Carney-esque Mansion House moment?

The Day Today 19 Feb 2015

* ECB give Greece an extra 3.3bn EUR in ELA, to be reviewed in 2 weeks

* Fed Minutes: prefer to keep rates lower for longer (Hilsenrath), and dollar strength “expected to be a persistent source of restraint” on exports
* They also discussed looking at “trimmed mean measures of inflation” as deflation has been focused on a “narrow range of items in households’ consumption basket”

* US Economic surprise index at its lowest for 2 yrs

* Japan’s LDP finance panel chief Shibayama: “I don’t think the reflationary policies are bad, but we’re in a tight spot right now with nationwide local elections just two months away”

* S&P warns Australia’s AAA rating under pressure, due to commodity price fall

Now you’re gonna believe us!

The Fed’s Williams has given a remarkably clear interview in today’s FT, which sets us up nicely for the Fed Minutes this Friday and then Yellen’s testimony on February 24th. He couldn’t sound more relaxed about the oil price fall, a stronger dollar or lower US yields, and his main obsession is pointing out how monetary policy operates with lags. This suggests that last week’s paper from the new head of the Fed’s monetary affairs should be interpreted as follows…. That paper said that the boost to inflation from all the QEs would not reach its peak until the start of NEXT year; by which point the most precipitous part of the oil price decline should have faded, meaning that inflation will be edging back towards the Fed’s target. So you need to make changes to monetary policy NOW or you run the risk of having to hike much more later. It is effectively the argument of the Bank of England’s hawks (before they ran panicking back into the dovecote):

‘Here is my concern. You wait so long that you get behind the curve and then you have to raise rates really rapidly and that creates a lot of market turmoil and maybe even potential damage to the economic recovery. I would rather go gradually, thoughtfully in adjusting policy than waiting too long and having to catch up.’

He thinks the bond market may keep long-term rates low due to extraordinary stimulus from the ECB and the BOJ but eventually they’ll learn:

If people expect the Fed to raise over the next several years interest rates to 3 or 3.5 per cent short term, something like that, they sure won’t be taking a 1.66 yield on a 10-year Treasury’

As Williams concludes:

‘Once you have got to the point where it is appropriate to do this, just do this . . . I don’t think we can go into this assuming we will have smooth sailing and there won’t be some kind of market reactions and upset, mainly because we are in this extraordinary period where much of the globe is moving in one direction and we are moving in the other. But I wouldn’t see this as being a huge risk or a danger or an argument against doing what is the appropriate thing.’

If Yellen concurs with this in her testimony then we really are off to the races for the dollar… Use your imagination, we could be looking at a 40-50% rally once again….

And what of the Fed?

Today’s payrolls number is in some ways irrelevant to the future fortunes of the dollar. The employment picture has been improving, and yet market expectations have pushed back the first Fed hike, with it now priced by October. In the wake of the oil price collapse, the focus has instead turned to inflation. Of course, a weaker number today, sub 200, would kick start worries that the Fed will be following the easing path laid out by every other central bank. But we won’t know their reaction function for sure until the set piece events of the next 6 weeks: Yellen’s semi-annual testimony and the FOMC meeting of March 19th.

Yesterday saw the release of a new paper that might shed some light on Yellen’s thinking. It is the first paper by Thomas Laubach since he was appointed the Fed’s Head of Monetary Affairs in January. He’s a significant appointment, because this is the division that is central to the planning of monetary policy. His appointment was seen as Yellen being able to appoint ‘her man’ at a time when the Fed are starting to think about the exit. Laubach was so instrumental in helping put together Yellen’s “optimal control” policy that she thanked him in her 2012 speech on the policy.

“Optimal control”, for those who may lead more exciting lives than Blondemoney’s inner central bank geek, was a policy that suggested you could exercise control over variables such as inflation, purely by the way you conduct and communicate monetary policy. Initially the models suggested that you keep rates lower for longer, and let inflation potentially rise in the long-run, so that unemployment remains low. However an update of this model last October suggested that rates needed to be going up already, because although inflation is sticky on the downside, it might also be sticky on the upside and hard to bring under control. So, get the hikes in now, then do fewer later (which was always the argument of the hawks at the Bank of England):

Optimal control

This new paper by Laubach, “The Macroeconomic effects of the Federal Reserve’s Unconventional Monetary Policies”, contains the following conclusions:

1. We haven’t yet felt the full impact of all of the QEs. The boost to employment is only expected to peak this quarter, while the boost to inflation isn’t expected to peak until early next year!

The peak unemployment effect—subtracting 1¼ percentage points from the unemployment rate relative to what would have occurred in the absence of the unconventional policy actions—does not occur until early 2015, while the peak inflation effect—adding ½ percentage point to the inflation rate—is not anticipated until early 2016′

2. It took so long for the stimulus to feed through because people kept expecting the recovery to come through sooner, and were disappointed

The net stimulus to real activity and inflation was limited by the gradual nature of the changes in policy expectations and term premium effects, as well as by a persistent belief on the part of the public that the pace of recovery would be much faster than proved to be the case’

3. But the good news is that people will have learnt from this episode (!) and next time, as long as the Fed are credibly committed to a big response, will adjust their expectations immediately. So the economy will improve more quickly. Here’s their charts of GDP, unemployment and inflation in the absence of all the QEs, then with expectations from 2013 applied in 2009:

Absence of unconventional policy unconventional policy with 2013 expectations

GDP would have headed back to 4% and only just dipped below 2%; unemployment would have come down quicker, and inflation would not be so depressed.

So what can we conclude from all this?

– If you want to make an impact: Go early, go big, and be credible.
– For Fed policy from here? There is still a boost to inflation feeding through the system, so if you think we are reaching the lows of inflation now, next year will be even higher inflation than you thought.

The question for the FOMC remains: do you wait, and run the risk of doing much more later? Or go early, and do less. Fortune favours the brave, but we’ll see just how brave Janet Yellen is in her semi annual testimony!


Hands up if you’re not easing, Part 372

The RBNZ ditched their reference to the fact that rate rises might be required in future, instead saying only that they expect to be “on hold for some time”. They warned again that the level of the NZD was ‘unjustifiable’ and ‘unsustainable’ and the currency duly dropped to four year lows against the dollar.

And what of the Fed? Their statement changed very little, noting only that inflation and ‘market-based measures of inflation expectations’ had fallen substantially – but they inserted a line that recent declines in energy prices have boosted household purchasing power”which sounds upbeat about the impact of the oil price decline. There was one other addition – the reference to “international” developments. There is some speculation that this might refer in coded terms to the dollar’s strength, with the argument that the Fed can’t refer directly to the dollar as it’s the remit of the Treasury. We will find out more with the publication of the Minutes on the 18th of February. 

It looks like this was a missed opportunity, if the Fed had wanted to join the chorus of easing. They’re putting their hands up.

This could have a significant impact for US stock markets. European stockmarkets are already catching up with the performance of the S&P, and now we have had a poor US earnings season. More importantly, a number of US companies have referred to dollar strength as the reason for their poor outlooks:

– Proctor & Gamble said it had been hit by “the most significant fiscal year currency impact” in its 178 year history
– DuPont warned its EPS would only grow by 5% this year because of currency effects
– United Technologies cut its earnings guidance only a month after its previous forecast, because of the impact of the dollar

You can understand from these comments why it used to be the case that a weaker dollar accompanied a rising stock market. This relationship changed in the past couple of years, where stocks rose alongside a rising/stable dollar. Here’s a quarterly chart where you can see the divergence in the mid 2000s – the red line (S&P) was rising as the dollar index (black line) was falling:

SP500 vs DXY


This past year has seen a close correlation between the percentage change in the S&P and the dollar index:

S&P500 vs DXY past year

Yet stocks are now starting to look wobbly indeed, closing once again below this trendline:

S&P500 daily 1 year chart


If we are going to see a wholesale reallocation out of US stocks and into those where there is a huge monetary boost, such as Europe or Japan, then can the dollar continue to rise? Will the Fed blink at its next meeting in March?

Were they putting their hands up last night, only to put them down again later and say, sorry, I thought you were asking a different question? Maybe they just wanted to be excused so they could visit the facilities and have a little sleep while they watch how the world pans out without them…