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.
Bernanke’s jobs pivot
Jason Lange contributed to this post
Fed Chairman Ben Bernanke made no direct references to the outlook for monetary policy in a speech to the National Association for Business Economics on Monday. But the message from his heavy focus on a weak labor market was pretty clear: The Fed is not considering tightening policy in the near future and stands ready to do more if growth doesn’t pick up steam this year. Ironically, Bernanke’s pessimism cheered the markets – by signaling that another round of stimulus is not off the table.
Andrew Wilkinson at Miller Tabak captured Bernanke’s feat for the day:
It ain’t what you say it’s the way that you say it – at least that’s what Chairman Bernanke found out on Monday by not mentioning further quantitative easing.
After its last two meetings, the Fed said it would likely keep rates near zero at least through late 2014. But upbeat economic signs, including solid employment growth, have led investors to bet on a move as early as the middle of next year. Bernanke’s speech appeared aimed at pushing back against those expectations.
Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi, reacted to the speech on the sidelines of the NABE conference.
Reading between the lines, it sounds like he’s pushing the ball forward towards having a discussion about doing more.
Bernanke and irrational markets
Sometimes, markets just don’t make a lot of sense. Take Fed Chairman Ben Bernanke’s two-day testimony this week. Bernanke was his usual dovish self on Wednesday, emphasizing risks to U.S. growth and the likelihood of slow progress on bringing down the jobless rate. Yet global markets suddenly panicked, apparently because the Fed chief did not directly give any hints of imminent easing. It’s surprising that markets would be surprised by this, however, given that few expected any such signals.
On Thursday, however, stocks recovered their footing. By then, it was time for the bond market to use the old Bernanke excuse for a decent selloff of its own.
Yet the basic message in both days of testimony was that economic conditions are still not to the central bank’s liking and that further action does remain on the table. Bernanke’s lack of faith in the recovery is striking:
The decline in the unemployment rate over the past year has been somewhat more rapid than might have been expected, given that the economy appears to have been growing during that time frame at or below its longer-term trend; continued improvement in the job market is likely to require stronger growth in final demand and production. Notwithstanding the better recent data, the job market remains far from normal: The unemployment rate remains elevated, long-term unemployment is still near record levels, and the number of persons working part time for economic reasons is very high.
Household spending advanced moderately in the second half of last year, boosted by a fourth-quarter surge in motor vehicle purchases that was facilitated by an easing of constraints on supply related to the earthquake in Japan. However, the fundamentals that support spending continue to be weak: Real household income and wealth were flat in 2011, and access to credit remained restricted for many potential borrowers. Consumer sentiment, which dropped sharply last summer, has since rebounded but remains relatively low.
Markets also appeared to ignore a fairly strong statement from the Chairman in response to lawmakers’ concerns that low interest rates are punishing savers:
It is arguable that the interest are too high that they are being constrained by the fact that interest rates cannot go below zero. We have an economy where demand falls far short of the capacity of the economy to produce, we have an economy where the amount of investment and durable goods spending is far less than the capacity of the economy to produce. That suggests that interest rates in some sense should be lower than higher, we cannot make interest rates lower of course, only can go down to zero, and again I would argue that a healthy economy with good returns is the best way to get returns to savers.
Is there a skills gap at the Fed?
Ask most economists why the distribution of wealth in the United States has become so unequal over the last three decades and they will likely offer a two word answer: skills gap. They point out that Americans with a college education have a lower jobless rate than those without one, and that better-educated workers make more money than their counterparts.
Yet as regional Federal Reserve presidents disclosed their personal asset holdings for the first time ever, the figures showed a gaping range: from the tens of thousands to the tens of millions.
The report showed the wealthiest officials, Richard Fisher and William Dudley of the Dallas and New York Feds respectively, made millions working the financial industry – Fisher running a hedge fund and Dudley as chief U.S. economist and partner at Goldman Sachs. It would be tough to argue that the two are any more skilled than the career PhD Fed economists who were at the bottom of the list.
James Galbraith of the University of Texas at Austin LBJ School said in response to an email request for comment:
The Fed data show one of two things: either the skills gap is bunk, or the profession of economics (which invented the notion of a skills gap) does not impart valuable skills. Either way, the news for the economists is not good.
In 2007, inequality reached levels not seen since the Great Depression – the first of many hyperbolic comparisons to the 1930s that would soon follow with the onset of a massive financial crisis. In February of that year, Fed Chairman Bernanke gave his only speech ever directly on the topic of inequality. Here is how he described the “skills gap”:
A key observation is that, over the past few decades, the real wages of workers with more years of formal education have increased more quickly than those of workers with fewer years of formal education. … To a significant extent, to explain increasing inequality we must explain why the economic return to education and to the development of skills more generally has continued to rise.
In good company: Bernanke backs Tarullo on housing-targeted QE3
The Federal Reserve, which on Wednesday sharply downgraded its outlook for U.S. economic growth and employment, appears to be seriously considering another round of monetary easing. In what would represent a policy U-turn, any third round of quantitative easing or QE3 appears increasingly likely to be heavily tilted toward purchases of mortgage-backed securities.
The idea was recently floated rather surprisingly by Fed Governor Daniel Tarullo, who normally focuses on regulatory issues. Some analysts had speculated Tarullo might not have broad support, but Fed Chairman Ben Bernanke’s comments on the matter during his post-meeting press conference on Wednesday suggested otherwise:
The housing sector is a very important sector. Problems in that sector are a big reason why our economy’s not recovering more quickly. I do think that purchases of mortgage-backed securities is a viable option. Certainly, something we would consider if the condition were appropriate. So the answer is yes, we will certainly look into that.
Whether any such program would have the intended effect remains to be seen. The Fed already bought some $1.25 trillion of MBS as part of its first round of quantitative easing, to only modest effect. The central bank seems to be hoping that if its actions coincide with the government’s push for broader foreclosure relief, they may raise the chances of success. The U.S. housing slump has been ongoing now for over five years, with home values having fallen by about a third nationwide.
Busy week of Fed speak
Will they or won’t they (ease monetary policy further)? The question will again garner investors’ attention this week as Federal Reserve Chairman Ben Bernanke and a number of regional Fed bank presidents take to the podium. The speeches come against a backdrop of ongoing worries about economic growth, but on the heels of a number of releases that were not as bad as feared. The bar remains high for the Fed to actively engage in a third round of quantitative easing or QE3 — it would probably take renewed deflationary rumblings to get there.
For now, the Fed is likely to focus on less drastic steps, such as new ways of communicating its policy targets, to satiate wobbly financial markets’ apparent need for ongoing monetary support. Here is the line-up of speakers for this week:
Bernanke will deliver remarks on ”The Effects of the Great Recession on Central Bank Doctrine and Practice” at the Boston Fed on Tuesday at 1: 15 pm EDT.
Monday: Chicago Fed President Charles Evans will speak on “U.S. Monetary Policy and Economic Outlook” before the Michigan Council on Economic Education at 1:15 pm EDT. Jeffrey Lacker of the Richmond Fed also give a talk on the outlook, speaking at 7:30 pm EDT an event sponsored by the Salisbury-Wicomico Economic Development.
Tuesday: Atlanta Fed President Dennis Lockhart will give remarks on the economy before the Chartered Financial Analyst Society of East Tennessee in Chattanooga at .
Wednesday: The Fed releases its monthly Beige Book, a collection of anecdotal data on economic conditions around its 12 districts.
Thursday: Fed Board Governor Daniel Tarullo speaks on “Unemployment, the Labor Market, and the Economy” at the Columbia University World Leaders Forum in New York at 6 pm EDT. Cleveland Fed President Sandra Pianalto speaks at a manufacturing conference in Toledo, Ohio.
Friday: Minneapolis Fed President Narayana Kocherlakota will give a speech to the Harvard Club of Minnesota at noon CDT.
Don’t know about you, but I’m exhausted already.
QE3 more plausible if inflation expectations keep falling
When it comes to the price stability half of their mandate, Federal Reserve officials have made one thing clear: they will not allow inflation expectations to veer very far from their preferred path. That’s because they believe inflation expectations are a good proxy for the pace of future price increases.
This applies both to the upside, when rising prices are a problem, and when the opposite is true, and policymakers fear deflation. The Fed argues that its second round of quantitative easing or QE2, when it purchased $600 billion in Treasury bonds, averted the risk of such a downward spiral of falling prices and wages, which can take years to overcome.
That’s why the latest figures from the Thomson Reuters/University of Michigan survey of consumer sentiment may strike a chord, particularly with the Fed’s more dovish camp. Inflation expectations one-year out dipped to 3.2 percent from 3.3 percent. Even more strikingly, 5-years out, consumers’ inflation projection fell to 2.7 percent from 2.9 percent. That was the lowest in a year and just 0.1 percentage point above the mid-crisis low of 2.6 percent.
Central bank officials also like to look at market-based measures, which derive investors’ expectations of inflation from the spread between regular bonds and ones that guarantee protection against inflation. Those readings have also been coming down, prompting Fed Chairman Ben Bernanke to respond to a question from an economics student in Cleveland last month with the following comment:
It is something that we’re going to be watching very carefully. If inflation falls too low or inflation expectations fall too low, that would be something we have to respond to because we do not want deflation.
The Fed’s toolkit: down but not quite out
U.S. Federal Reserve officials mulled a fresh round of bond purchases among other policy tools to ease financial conditions, according to minutes of their September meeting.
Fed officials discussed measures to ease monetary policy ranging from lengthening the average maturity in the Fed’s portfolio to lower long-term interest rates — the step they ultimately took last month — to providing explicit guidance about their goals for the labor market.
In a move known as Operation Twist, the Fed committed to selling $400 billion in short-dated Treasuries and use the money to purchase longer-term bonds. Following are some of the additional measures officials are debating:
BOLSTER POLICY ASSURANCE, SET TARGETS
Communications steps are the lowest hanging fruit for Fed policy, since it requires only verbal assurances rather than commitment of new funds.
The Fed in August took the unprecedented step of offering a specific time frame for which it would likely to keep policy ultra-loose, saying it expected economic conditions would warrant an exceptionally low federal funds rate at least through the middle of 2013.
While three officials dissented against the move, others wanted to take bolder steps immediately. The central bank actively discussed something akin to a price-level targeting system where policymakers would explicitly link the path of interest rates to the direction of unemployment and inflation.
The big easy: Bernanke readies September move
Fed Chairman Ben Bernanke’s speech to the Economic Club of Minnesota was long on theory and short on details. Still, Bernanke made one thing clear: the central bank is revving up to ease monetary policy further. Most analysts are looking for some sort of effort to push down long-term rates at the September meeting. While Bernanke did not offer any further guidance on method, he did present a very distinctive sense of direction.
A renewed focus on growth ratcheted the Fed chief’s tone up a notch from his remarks at Jackson Hole:
The Federal Reserve will certainly do all that it can to help restore high rates of growth and employment in a context of price stability.
Bernanke also appeared keen to assuage the concerns of more hawkish Fed members.
We see little indication that the higher rate of inflation experienced so far this year has become ingrained in the economy.
And later in the speech:
In addition to the stability of longer-term inflation expectations, the substantial amount of resource slack that exists in U.S. labor and product markets should continue to have a moderating influence on inflationary pressures. Notably, because of ongoing weakness in labor demand over the course of the recovery, nominal wage increases have been roughly offset by productivity gains, leaving the level of unit labor costs close to where it had stood at the onset of the recession. Given the large share of labor costs in the production costs of most firms, subdued unit labor costs should be an important restraining influence on inflation.
Dissents at the Fed: 435 and counting
Think three dissents at the consensus-loving Federal Reserve are a lot? Try 435. According to St. Louis Fed President James Bullard, that’s how many dissents have been logged since 1936 by U.S. central bank policymakers unhappy with the decisions of the majority of their colleagues.
Internal disagreement at the Fed is unquestionably high, so much so that Fed Chairman Ben Bernanke on Friday said policymakers would meet for two days in September, not just one, to discuss their options more fully. Three regional Fed presidents — Dallas Fed’s Richard Fisher, Philadelphia Fed’s Charles Plosser, and Minneapolis Fed’s Narayana Kocherlakota — cast their vote against the Fed’s decision earlier this month to freeze short-term interest rates for two years.
“It depends a lot on the personalities involved, it depends a lot on the situation,” Bullard said of why some decisions draw more dissents than others. Bullard, who does not have a vote this year on the Fed’s policy-setting committee, said he also would have dissented, as did Kansas City Fed President Thomas Hoenig, the host of the annual Jackson Hole meeting of central bankers.
But Bullard said it would be wrong to think that the panel always splits between regional Fed presidents and the Washington-based Fed Board members, who are often seen as more closely aligned with the chairman. Over the years dissents have split nearly evenly between the two groups, he said.
