MacroScope

Bernanke’s seven-percent solution

 

Federal Reserve Chairman Ben Bernanke has a problem: how to wean markets from dependence on central bank stimulus. On Wednesday Bernanke did what some of his most dovish colleagues have urged for months. He laid out a clear path for how and when the Fed will bring its third round of bond-buying to a close.

It doesn’t take a master detective to figure out his solution – 7 percent.

“If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it will be appropriate to moderate the monthly pace of purchases later this year, and if the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year,” Bernanke said in a press conference following the Fed’s two-day policy-setting meeting.

“In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains.”

Bernanke’s seven-percent solution has not elicited from markets the same “long sigh of satisfaction” that Sherlock Holmes emitted after shooting up in “The Sign of Four.”

Far from it: stocks tanked and borrowing costs – as measured by yields on U.S. Treasuries – soared.

Why low inflation may not prevent the Fed from reducing QE

Everybody knows U.S. unemployment, currently at 7.6%, is still too high – especially the millions of Americans struggling to find work. Less widely acknowledged is a recent dip in inflation that puts it well below the Federal Reserve’s 2 percent target. Indeed, at 0.7 percent in April, the Fed’s preferred inflation measure was less than half of the central bank’s explicitly stated goal. So why are Fed officials, gathered in Washington for their latest policy decision today, discussing a pullback in stimulus rather than an increase in it?

According to some economists, it’s because policymakers believe the recent decline in inflation will be transitory and that the rate will gradually move back up toward target as growth picks up during the rest of this year and in 2014. Yesterday’s report on consumer prices corroborated that prospect for some analysts.

Paul Ashworth, chief US economist at Capital Economics, wrote:

The low level of headline inflation largely reflects the drop back in commodity prices over the past 12 months, with even the low core rate partly explained by the indirect impact of those lower commodity prices. Under those circumstances, we wouldn’t expect the Fed to put too much weight on inflation being below its target. Once commodity prices level out, the downward pressure on consumer goods prices will begin to ease. In other words, this won’t prevent the Fed from beginning to reduce its monthly asset purchases, probably beginning in September.

The chairman’s challenge: Bernanke says ‘taper,’ markets hear ‘tighten’

For a central bank that likes to tout the importance of clear communication, the Federal Reserve sure knows how to be obtuse when it wants to. Take Bernanke’s testimony before the Joint Economic Committee of Congress last month. His prepared remarks were reliably dovish, emphasizing weakness in the labor market and offering no hint of an imminent end to the current stimulus program, which involves the monthly purchase of $85 billion in assets.

It was during the question and answer session that the real fireworks came. Asked about the prospect for curtailing such bond buys, Bernanke said:

If we see continued improvement and we have confidence that that’s going to be sustained then we could in the next few meetings … take a step down in our pace of purchases. If we do that it would not mean that we are automatically aiming towards a complete wind down. Rather we would be looking beyond that to see how the economy evolves and we could either raise or lower our pace of purchases going forward.

What’s a Fed to do? Taper talk persists despite missed jobs, inflation targets

As the Federal Reserve meets this week, unemployment is still too high and inflation remains, well, too low. That makes some investors wonder why policymakers are talking about curtailing their asset-buying stimulus plan. True, job growth has averaged a solid 172,000 net new positions per month over the last year, going at least some way to meeting the Fed’s criteria of substantial improvement for halting bond purchases.

So, either policymakers see brighter skies ahead or they want to get out of QE3 for other reasons they may rather not air too publicly: worries about efficacy or possible financial market bubbles.

“I don’t think the data dependent emphasis is the only ball the Fed is focusing on when mulling over the pace and extent of asset purchases,” says Thomas Lam, chief economist at OSK-DSG.

What’s in a (trend payrolls) number? The Chicago Fed paper that shook the markets, ever so slightly

      

Ann Saphir contributed to this post

The apparent conclusion from one of the most dovish regional Federal Reserve banks was rather surprising: The economy may actually need much smaller monthly job growth, of around 80,000 or less, in coming years in order for the jobless rate to keep moving lower. The immediate policy implication, it might seem, is that the U.S. central bank may have to tighten monetary policy much sooner than previously thought.

Andrew Brenner of National Alliance remarked that, while the report should be taken with a grain of salt, “this translates to lowering the bar to QE tapering.”

Right? Not necessarily, writes Goldman Sachs economist Jan Hatzius. Here’s why:

Forget the ‘wealth effect’: real wages drive U.S. consumer spending

 

Federal Reserve officials have touted the ‘wealth effect’ from higher stock prices and rising home values as a key way in which monetary policy boosts consumer spending and economic activity. But according to the results of a recent survey from the Royal Bank of Canada, that ethereal feeling of being richer on paper is no substitute for cold, hard cash.

Here’s how Fed Chairman Ben Bernanke explained the benefits of rising asset prices to the real economy during a press conference in September.

The tools we have involve affecting financial asset prices and those are the tools of monetary policy. There are a number of different channels – mortgage rates, I mentioned corporate bond rates, but also prices of various assets, like for example the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they’ll feel more disposed to spend. If house prices are rising people may be more willing to buy homes because they think that they will make a better return on that purchase. So house prices is one vehicle.

Inflation, not jobs, may hold key to Fed exit

It’s that time of the month again: Wall Street is anxiously awaiting the monthly employment figures – less because of its interest in job creation and more because of what the numbers will mean for the Federal Reserve’s unconventional stimulus policies.

As one money manager put it all too candidly: “Bad news is good news in this market lately because it keeps the Fed buying bonds and interest rates low.”

Given that the Fed is the closest thing the world has to a global central bank, what happens at the Federal Open Market Committee doesn’t often stay in the Federal Open Market Committee. Indeed, emerging markets have become increasingly volatile since Fed Chairman Ben Bernanke said policymakers might curtail the pace of asset buys in coming months.

The rationale for a December Fed taper

Vincent Reinhart, a former top Federal Reserve researcher who is now chief U.S. economist at Morgan Stanley, believes the U.S. central bank will begin pulling back on the pace of asset purchases in December. Here’s how he arrives at that timeline:

We believe the Fed is going to need to see four employment reports averaging net gains in nonfarm payrolls of at least 200,000 to justify reducing the pace of its asset purchases. The arithmetic of the calendar would then put the earliest date of tapering/tightening in September, which conveniently for the Fed is a meeting followed by a press conference.

Our economic forecast, however, suggests that there will be more slip-sliding through the soft patch, implying that December is the more likely start.

Is Congress the ‘enabler’ of a loose Fed?

We heard it more than once at today’s hearing of the Joint Economic Committee featuring Fed Chairman Ben Bernanke: the central bank’s low interest rate policies are allowing Congress to delay tough decisions on long-term spending.

As U.S. senator Dan Coats asked pointedly: “Is the Fed being an enabler for an addiction Congress can’t overcome?”

Yet, if you read the subtext of Bernanke’s testimony closely, it may actually be Congress that is enabling a loose Federal Reserve.

What to expect from Bernanke testimony and Fed minutes this week

Financial markets this will be keenly focused on congressional testimony from Fed Chairman Ben Bernanke and minutes from the central bank’s April 30-May 1 meeting, particularly given a thin data calendar. The latter may be the more interesting one, since it will offer hints into how far Fed officials are leaning in a direction of curbing the pace of its bond-buying stimulus, potentially late this summer.

The economic backdrop has been just mixed enough to leave policymakers cautious about taking their foot off the gas. Still, if we get a few more months of strength in the labor market, Fed officials may just be able to say “substantial progress” has been made in the outlook for the labor market – their stated precondition for an end to asset buys.

Still, Harm Bandholz at Unicredit says markets should not confuse a debate about tapering bond buys with some immediate reversal of the Fed’s policy of ultra low rates.