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from MacroScope:

In QE3 waltz, Fed again steps toward easing

On again, off again. That’s been the story with prospects for another round of monetary stimulus from the Federal Reserve. Expectations for a third installment of quantitative easing, the much-debated QE3, had ebbed with improving economic data in the first quarter – but are now flowing anew.

Following a weak employment report for last month, the latest hint that more bond buys could be in the offing came from minutes of the central bank’s April meeting, which saw the Fed leave rates near zero and repeat that it would likely hold them there until at least late 2014. Policymakers appeared to be taking an increasingly dim view of economic prospects given an array of looming threats to growth, even if none are particularly new.

According to the minutes:

Participants identified several downside risks to the projected pace of economic expansion, including the fiscal and financial strains in the euro area and the possibility of an abrupt fiscal consolidation in the United States.

To Millan Mulraine at TD Securities, the more negative tone suggested a modestly greater inclination to lean in the direction of easing. In particular, Mulraine singles out this sentence in the minutes:

Several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough.

Writes Mulraine:

from MacroScope:

Jobs or inflation — Is the Fed distracted?

The Federal Reserve doesn’t get much love from Washington these days but it did receive a rare bit of political backing on Wednesday as Democrats defended its role in promoting full employment as well as stable prices.

The U.S. central bank has been the target of criticism from members of both political parties as a result of bank bailouts and hands-off rule-enforcement that let predatory and unsound lending practices go unchecked, among other shortfalls.

But discussing legislation narrowing the Fed’s mandate to a single-minded focus on price stability, Democrats questioned the need to drop the full employment side of the dual mandate.

“Is it a problem?” asked Minnesotan Keith Ellison. “To the degree that we have problems with monetary policy, is the dual mandate the cause?”

Ellison said that far from distracting the Fed, the lofty 8.1 percent unemployment rate should get greater attention. “This is a national disgrace,” he said.

Ron Paul, a presidential candidate who chairs a subcommittee on domestic monetary policy, held a hearing to discuss several pieces of legislation changing the Fed’s mandate. Two of these would limit the Fed’s focus to price stability.

With partisan divisions and other priorities, Congress is unlikely to make any changes to the Fed’s mandate this year. But the effort could gain momentum if Republicans control both houses of Congress after November.

from Global Investing:

Three snapshots for Thursday

The European Central Bank kept interest rates on hold on Thursday.  President Mario Draghi urged euro zone governments to agree a growth strategy to go hand in hand with fiscal discipline, but as thousands of Spaniards protested in the streets he gave no sign the bank would do more to address people's fears about the economy

The divergence between Euro zone countries is starting to impact analyst estimates for earnings. As this chart shows earnings forecasts for Spain and Portugal are seeing more downgrades than Germany or France.

The inflation rate in Turkey rose to 11.1% in April, putting pressure on the central bank to raise interest rates:

from MacroScope:

Put your rate hike where your mouth is

Jonathan Spicer and Van Tsui contributed to this post.

This week, for the second time ever, the U.S. Federal Reserve published policymakers’ forecasts for when the central bank should start raising rates. The chart suggested a split Fed, with three policymakers expecting a rate rise this year, three next year, seven in 2014 and four in 2015. That’s useful information, as far as it goes.

But as much as the Fed has embraced transparency in recent years, it stopped short of saying which policymaker backs a rate hike in which year – a key bit of data for grasping where the voters on Fed Chairman Ben Bernanke’s policy-setting committee stand, and how their positions shift over time.

Below is the bar graph that the Fed published Wednesday, with Reuters’ best estimates of who fell where. We stand ready be convinced otherwise by readers offering evidence or insight that supports a different view. Send us an email, gives us a call, write a comment or shout us out on Twitter.

You can find more information about the policy leanings of each top Fed official in our handy interactive hawks-doves chart.

from MacroScope:

Bernanke: U.S. is not Japan, and I have not changed my mind

Of all the questions Federal Reserve Chairman Ben Bernanke was asked during his press conference on Wednesday, one appeared to pique his interest in particular: Was he being less aggressive as central bank chairman than the advice he dished out to Japan as an academic in the 1990s would prescribe?

It was the second half of the question asked by Binyamin Applebaum and yet the chairman was eager to get right to it: “Let me tackle that second part first,” he began.

Applebaum may have been channeling the Nobel-winning economist Paul Krugman, a Princeton colleague of Bernanke’s and critic of Fed policy, who recently argued the Fed chief was being inconsistent and overly cautious.

Bernanke argued that the Fed has done a lot already to support growth and bring down unemployment. Actively aiming for higher inflation with additional use of unconventional tools would risk the central bank’s long-term credibility. Here is his answer in full:

So there’s this view circulating that the views I expressed about 15 years ago on the Bank of Japan are somehow inconsistent with our current policies. That is absolutely incorrect. My views and our policies today are completely consistent with the views that I held at that time.

I made two points at that time to the Bank of Japan. The first was that I believe that a determined central bank could and should work to eliminate deflation – that is, falling prices. The second point that I made was that when short-term interest rates hit zero, the tools of a central bank are no longer – are not exhausted. There are still other things that the central bank can do to create additional accommodation.

Now, looking at the current situation in the United States, we are not in deflation. When deflation became a significant risk in late 2010, or at least a modest risk in late 2010, we used additional balance sheet tools to help return inflation close to the 2 percent target. Likewise, we have been aggressive and creative in using non-federal-funds-rate-centered tools to achieve additional accommodation for the U.S. economy.

So the very critical difference between the Japanese situation 15 years ago and the U.S. situation today is that Japan was in deflation. And, clearly, when you’re in deflation, and in recession, then both sides of your mandate, so to speak, are demanding additional accommodation. In this case, we are not in deflation. We have an inflation rate that’s close to our objective.

Now, why don’t we do more? Well, first I would again reiterate that we are doing a great deal. The policy is extraordinarily accommodative. We – and I won’t go through the list again, but you know all the things that we have done to try to provide support to the economy. I guess the question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased reduction – a slightly increased pace of reduction in the unemployment rate?

The view of the committee is that that would be very reckless. We have – we, the Federal Reserve, have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we’ve been able to take strong accommodative actions in the last four, five years to support the economy without leading to an unanchoring of inflation expectations or a destabilization of inflation. To risk that asset for what I think would be quite tentative and perhaps doubtful gains on the real side would be, I think, an unwise thing to do.

from MacroScope:

Listen to FOMC, ignore the dots

Federal Reserve Chairman Ben Bernanke was asked about the discrepancy between individual rate forecasts of policymakers, many of whom -- represented as dots on a chart -- see rates rising in the next couple of years, and the Federal Open Market Committee’s statement that it sees rates staying low until late 2014. Bernanke’s answer was clear: the FOMC is king.

The individual projections are inputs to the committee decision, so the committee decision is the critical element in that respect. The committee was quite comfortable with the consensus that we have reported today.

from MacroScope:

Resolving Shirakawa’s conundrum

The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:

It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.

Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:

At the moment, such expectations are not firmly backed by concrete reform plans. The public therefore restrains spending on concerns over future fiscal developments. This constitutes one factor behind sluggish economic growth and mild deflation. If this is indeed the case, the experience of Japan indicates a possibility that a cumulative increase in government debt combined with weak economic growth expectations might generate deflationary pressures.

Not so, argues Ugo Panizza, head of debt and finance analysis at the United Nations Conference on Trade and Development. He and co-author Andrea Presbitero find no causal link between high debt levels and weak economic growth.

Christopher Sims, a Nobel-winning economist and Princeton professor also on the panel with Shirakawa, had a much simpler explanation for why Japanese yields are low while Europe’s face steady upward pressure even though both economies are struggling with soft growth:

from MacroScope:

Roubini takes on the ECB

It was fun to watch. Nouriel Roubini, NYU economist and crisis personality, was one of just five carefully selected individuals at a large gathering in the International Monetary Fund HQ1 building’s towering atrium who actually got to ask questions of the policymakers on stage.

Roubini was characteristically biting in his critique of conventional orthodoxy, singling out the European Central Bank for not having done enough to stem the euro zone’s two-year financial crisis. He challenged the notion that the ECB is powerless to boost growth further, suggesting -- to the clear discomfort of some policymakers in the room -- that measures to weaken the currency could provide a badly-needed boost to exports:

I saw that on the panel there are four central bankers and the panel is about fiscal policy and sovereign debt. So the natural question is then to think maybe about what could be the contribution of central banks in resolving sovereign debt issues. Now, one simple answer would be to just monetize very large budget deficits and I understand why a central bank would say that’s a no-no.

But there’s a more subtle argument and it’s the following one: we know that while fiscal austerity is necessary, in the short-run, as even Christine Lagarde said and the IMF’s work suggests, that has a net recessionary effect on the economy. You’re raising taxes, you’re reducing transfer payments, you’re reducing government spending, so you’re reducing disposable income, you’re reducing aggregate demand. It makes the recession worse and you can get a vicious circle. Not only do you have deleveraging of the public sector but the raising of taxes and cutting of transfer payments induces also deleveraging of the private sector.

So if domestic demand is going to be anemic and weak in this fiscal adjustment because of private and public sector deleveraging you need net exports to improve to restore growth. That’s what happened in emerging market crises. But in order to have an improvement in net exports you need a weaker currency and a much more easy monetary policy to help induce that nominal and real depreciation that is not occurring right now in the euro zone. That’s one of the reasons why we’re getting a recession that’s even more severe. So, can’t we think of monetary policy as helping to induce the change in relative prices that’s necessary to have a restoration of growth if domestic demand is weak through net export improvements?

Roubini was not alone in his critique either, with the ECB coming under pressure from the IMF itself to lower rates further.

ECB Vice President Vítor Constâncio responded by stressing the institution’s price stability mandate as well as the difficulties of synchronizing policy for a group of nations growing at different speeds:

We have only one monetary policy for the average of the euro area. Headline inflation is now at 2.7 (percent). We anticipate, and we have reasons to trust the forecast that inflation in the euro area will be below 2 at the beginning of next year. Nevertheless it’s about 2. Even if you consider core inflation, it’s now at 1.6 – so it’s clearly not in any way a deflation risk. And this would be the reason for us to have a different monetary policy than the one we have now, because that would be directly connected with our mandate regarding price stability in both directions. But that’s not the case right now.

So your implicit view, or recommendation if I may draw that from your question, really would fit much better, even appropriately, with the mandate of the Fed but it’s not what we have in the ECB.

Nevertheless we are doing a lot in view of the situation that inflation expectations are very firmly anchored. That has allowed us to do lots of things. We rely and trust that in the present situation with a weak economy we can be sure of complying with our primary objective so we can do other things and we have done that – but not what you hinted at.

Bank of France Governor Christian Noyer, who was hosting and moderating the event, had spoken about that very same subject earlier during the panel discussion. Like Constâncio, he argued markets should not expect central banks to shoulder too great a burden:

from MacroScope:

Monetary policy as a skimpy spare tire

Central bankers have said repeatedly since the start of the global financial crisis that monetary policy can only do so much to heal a broken economy. Agustín Carstens, president of Mexico’s central bank, chose an interesting analogy at an IMF event this weekend to describe the adjustment needed in countries with very high debt levels:

In relatively modern cars the spare tire is (pretty small). Basically that spare tire should be enough to take you to the next gas station. But if you want to drive your car (a very long distance) it’s likely you will never get there.

So today I think what central banks have done is that the tire was gone, they used the spare tire, the spare tire is this big, and you can go just a few miles to the next gas station and you repair the car. So, if they (the fiscal authorities) don’t do that then they will be left on the road.

Somebody call AAA.

from Global Investing:

Three snapshots for Thursday

Initial claims for state unemployment benefits slipped 2,000 to a seasonally adjusted 386,000, the Labor Department said. The prior week's figure was revised up to 388,000 from the previously reported 380,000.

The four-week moving average for new claims, considered a better measure of labor market trends, rose 5,500 to 374,750.

Brazil's central bank raised its key interest rate for a fourth straight time on Wednesday as it seeks to rein in persistent inflation, and indicated more rate increases could be on the way soon. This follows a 50bps rate cut from India earlier in the week.