Inflation no obstacle to more Fed easing
Another reason the Federal Reserve may have additional room for monetary easing: Inflation expectations fell sharply in May, according to the latest Thomson Reuters/University of Michigan survey of consumer sentiment. Inflation expectations five years out dropped to 2.7 percent in May, the lowest since January. Fed officials often say expectations are a key leading indicator of actual price increases.
Daniel Silver, economist at JP Morgan:
This level of longer-term inflation expectations is towards the bottom of the range that has been reported in recent years – 2.7% has been hit on several occasions (most recently between October 2011 and January 2012) and 2.6% was only reached back in December 2008 and March 2009, early on in the crisis period. Most other inflation measures that the Fed watches (including core PCE inflation and the 5yr-5yr breakeven inflation rate) have signaled that inflation expectations are still anchored and underlying inflation pressure is modest.
The downshift comes in the wake of inflation figures for April that also pointed to a tame price environment. This is why Eric Green at TD Securities argues “U.S. inflation favors the doves.”:
In many ways the release today is emblematic of what we expect to see on the inflation front over the next six months. That is, steady disinflation on headline prices (driven by roll over and seasonal effects from energy prices) and stable core prices. Headline inflation will fall through core next month as energy prices alone virtually ensure a gain of no more than 0.1%, probably less. As headline inflation drifts to 2.0% y/y next month (from 2.3% y/y April) and 1.8% y/y by August, the inflation metric will work in favor of the more dovish contingent on the FOMC.
Still, deflation fears, a key underpinning of the Fed’s second round of quantitative easing, are not likely to make a comback, says Green:
That does not mean we are in a period of disinflation akin to the pre-QE2 period. Inflation will not be the cause célèbre of more accommodation, it will merely be removed as a potential obstacle among those favoring stronger growth, and truth be told, higher inflation.
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.
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.
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.
Five reasons why the Fed would prefer to avoid QE3
The Fed appears to have moved away from the notion of additional bond purchases in recent weeks, for a mix of tactical and practical reasons including:
1. Policymakers worry about venturing any further into uncharted territory.
2. Growth isn’t weak enough to make a clear case for additional monetary easing.
3. Many officials think QE is better at thwarting deflation than boosting employment.
4. Cutting rates before a presidential election is probably not ideal timing.
5. Bernanke would like to save the Fed’s remaining ammunition for a truly rainy day.
And yet 11 of 15 primary dealers polled by Reuters following a disappointing March payrolls report still believe the central bank will ultimately embark on another bond-buying stimulus plan. Given the Fed’s rather high bar for further asset purchases, that must mean these banks expect the economic backdrop to get materially worse from here.
Selective transparency at the Fed
It’s something of a dissonant communications strategy: Fed officials are willing to tell us what they think will happen three years from now, but not what they discussed three years ago.
The Federal Reserve’s public relations arm holds up the chairmanship of Ben Bernanke as a model of transparency. And it’s true. Press conferences and federal funds rate forecasts are major steps forward for a central bank that until the mid-1990s didn’t even tell the markets what it was doing with interest rates.
Still, the old habits of secrecy die hard. Monetary policy transparency aside, the Fed has remained adamantly opaque in other ways – to the point that it took a Bloomberg News lawsuit for it to name the recipients of emergency era loans.
Similarly, it took a Freedom of Information Act request from MSNBC and The Huffington Post to obtain a mostly blacked out version of transcripts for Fed meetings during the worst of the U.S. financial crisis. The Fed only releases full transcripts of its meetings with a five year lag, arguing that this allows policymakers to conduct their discussions more freely.
New research from economists Xavier Freixa and Christian Laux examining the nature of regulatory failures during the crisis makes an interesting distinction between mere disclosure, the raw release of data, and transparency, which is a more directed effort to communicate that information to the public.
We interpret disclosure as providing information, while transparency arises when the information is effective in reaching the market, being adequately interpreted and used.
“We interpret disclosure as providing information, while transparency arises when the information is effective in reaching the market, being adequately interpreted and used.”
In other words, transparency only happens when you agree with the Fed’s all-knowing interpretation. If we give you the data before you would be likely to agree with us, that would be opaque disclosure.
Central bank balance sheets: Battle of the bulge
Central banks across the industrialized world responded aggressively to the global financial crisis that began in mid-2007 and in many ways remains with us today. Now, faced with sluggish recoveries, policymakers are reticent to embark on further unconventional monetary easing, fearing both internal criticism and political blowback. They are being forced to rely more on verbal guidance than actual stimulus to prevent markets from pricing in higher rates.
How do the world’s most prominent central banks stack up against each other? The Federal Reserve was extremely aggressive, more than tripling the size of its balance sheet from around $700-$800 billion pre-crisis to nearly 3 trillion today. Still, the ECB’s total asset holdings are actually larger than the Fed’s – it started from a higher base.
The Bank of England, for its part, went even deeper into uncharted territory, with its assets as a percentage of GDP surpassing the Fed’s. By the same measure, the ECB has overtaken the Bank of Japan, which has been grappling with deflation for some two decades and started from a much higher level.
Taken together, the expansion in reserves is impressive – and speaks to just how deep the global recession proved to be.
Fed policy, University of San Diego style
A Fed economist for nearly two decades, San Francisco Fed President John Williams also taught for half a year at Stanford’s Business School in 2008, but on Tuesday, his students appeared to be only half listening.
When Williams took the podium a warm, sunny day at the University of San Diego’s School of Business Administration, he argued that the U.S. central bank must press on with its easy money policy to boost the economy. The recovery is growing too slowly to trim unemployment very quickly, he told the audience of perhaps 200 students and professors, and inflation is set to fall below the Fed’s 2 percent target. The Fed, he emphasized, is nowhere close to raising rates.
After taking a few questions from students,Williams left to chat with reporters and then to head to the airport for his flight back home. Then, with the help of economists from the San Francisco Fed, students held a mock Fed policy-setting panel.
At the end of an hour’s discussion, by a 5-2 vote, they kept the Fed’s zero interest-rate policy in place – just as the Fed, by a vote of 9 to 1, had done in March. But the statement the students released – modeled on the one the Fed publishes after its regular policy-setting meeting – heavily underscored the possibility the Fed could tighten earlier than 2014. The two dissenters had argued for a more hawkish statement.
“The Fed reserves the right to alter from that path at a future date as conditions warrant,” the University of San Diego student statement said. “The duration commitment will not be extended past 2014.”
The statement was perhaps to be expected, given the hawkish bent of the policymakers the students chose to represent. Fed Chairman Ben Bernanke, governors Daniel Tarullo and Sarah Bloom Raskin, and regional Fed president William Dudley (New York) all voted in favor, as did, surprisingly, Kansas City’s Esther George. Charles Plosser (Philadelphia) and Richard Fisher (Dallas) both dissented.
Williams, whose policy views put him on the dovish end of the spectrum at the U.S. central bank, was not represented on the student panel; nor were Vice Chairman Janet Yellen, Cleveland Fed President Sandra Pianalto or other like-minded doves. Richmond Fed President Jeffrey Lacker, the lone dissenter in March’s real Fed decision, was also not represented.
The new dovish minority at the Fed
Suddenly, it’s the two lone doves who find themselves on the outside of the Federal Reserve’s policy consensus. Until recently, it was the hawks who were in the minority. But minutes of the central bank’s March meeting suggest policymakers are becoming less keen to launch a fresh round of monetary stimulus as the U.S. economy improves.
They key difference came from the minutes’ characterization of officials’ inclinations toward a third round of quantitative easing or QE3.
Here is what the January minutes had said:
A few members observed that, in their judgment, current and prospective economic conditions – including elevated unemployment and inflation at or below the Committee’s objective – could warrant the initiation of additional securities purchases before long. Other members indicated that such policy action could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate-consistent rate of 2 percent over the medium run.
Contrast that with March’s thinning ranks of QE3 proponents.
A couple of members indicated that the initiation of additional stimulus could become necessary if the economy lost momentum or if inflation seemed likely to remain below its mandate-consistent rate of 2 percent over the medium run.
Bernanke hit the stop-orders of the foolish investor-crowd before starting QE3. The winners will be the ones that succeed in keeping long positions…
http://dobrisratings.com/index.php?optio n=com_content&task=view&id=149523&Itemid =1
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.
