MacroScope

Like over-hyped Olympian, Fed set to disappoint

Pity the Federal Reserve. Like an over-hyped Olympian, the U.S. central bank enters this week’s policy meeting with sky-high expectations and a high probability of disappointment.

Markets are salivating at the prospect of a decisive easing move when Fed policymakers emerge from their meeting on Wednesday. The S&P 500 is up 3.6 percent in the last four sessions as traders hold out hope the Fed will launch a third round of quantitative easing, or QE3, to blast the U.S. economy out of its funk. Stumbling job creation, manufacturing and spending, as well as a measly 1.5 percent GDP growth in the second quarter and serious spillover threats ahead from Europe’s debt crisis, all feed this thesis. Fed policymakers from Chairman Ben Bernanke on down the line to Cleveland Fed President Sandra Pianalto and James Bullard of St. Louis have also stoked the market with a more dovish tone the last little while. And yet, this is probably not the time for a big policy move.

Topping the list of reasons to disappoint – and to knock the market down to size – the Fed probably doesn’t want to front-run the July employment report that’s due on Friday, and which will give a fresh sense whether the spring-summer slump in the labor market is temporary or more permanent. Waiting until the Fed’s next scheduled meeting, Sept. 12-13, would give policymakers the added benefit of the August jobs report. And speaking of front-running, the U.S. central bank may not want to get out just ahead of the European Central Bank’s policy decision on Thursday. If, down the line, things get really ugly in Europe – or if the U.S. Congress sends the country off the so-called fiscal cliff – the Fed will probably want to have the QE3 bazooka ready in its arsenal.

Which brings us to other, less aggressive possibilities when the Fed issues its policy statement Wednesday afternoon. ”I think the Fed can structure the statement in such a way that it would reduce disappointment” by citing, for example, the recent extension of Operation Twist and saying it will act if things don’t get better, said Dana Saporta, an economist at Credit Suisse. Operation Twist, in which the Fed extends its Treasury maturities, is set to run through the end of the year, providing a useful excuse not to act before the November U.S. election. The central bank could also take the relatively modest step on Wednesday of extending beyond “late 2014″ its conditional pledge to keep interest rates near zero, which would give it more time to work on new policy tools that were hinted in minutes from the June meeting.

Credit Suisse estimates that a 33-percent chance of QE3 has been priced into the market, ahead of this week’s meeting. But if the central bank were to unveil such a large-scale asset-buying program, it would probably drop like a confusing thud, given that Bernanke has no scheduled press conference at which he could justify it. ”If they’re going to do something, they probably want time to explain it,” said Sam Coffin, U.S. economist at UBS. The annual Fed conference in late August in Jackson Hole, Wyoming offers that time to explain, as does Bernanke’s press conference set for the September policy meeting.

Hints of recession in sleepy Richmond Fed data

It’s a report that gets little attention normally (We at Reuters geek out on Fed data a lot, and even we don’t write a story about it). But an unusually sharp contraction in the Richmond Fed’s services sector index for July caught the eye of some economists. The measure took a nosedive, falling to -11 this month, the lowest in over two years, from +11 in June.

Tom Porcelli at RBC says the plunge in new orders was downright scary:

Richmond Fed manufacturing got absolutely walloped in July. In fact, the all-important new orders component sank to an abysmal -25 from -7 in June and -1 two months ago. This is by far the weakest print since the recession. In fact, at no point has this metric been this low when we have not been in a recession.

To be sure, the data capture only two cycles prior to this one, but this doesn’t take away from the fact that the recent print is suggesting things could be much worse than advertised. We continue to hear how this year is “2011 all over again”, yet the data suggest it is materially worse.

Three years after last increase, business group calls for U.S. minimum wage hike

Bucking the usual tune of private sector lobbyists, a group called Business for a Fair Minimum Wage is calling for a hike in the minimum wage, saying it would boost business and the economy.

Business for a Fair Minimum Wage is a project of Business for Shared Prosperity, which describes itself as a national network of “forward thinking” business owners and executives.

The last step of a three-step federal minimum wage increase went into effect on July 24, 2009. The $7.25 an hour current minimum wage comes to just $15,080 a year for full-time work, below the poverty line.

Off the rails? Goldman lowers Q2 GDP ‘tracking’ estimate to 1.1 pct

Another round of bad news on the economy has prompted Goldman Sachs to shave another tenth of a percentage point off their already bleak second quarter U.S. GDP forecast.

The July Philadelphia Fed business activity index improved less than expected and remained “significantly negative,” pointing to a third month of contraction. Following news that June existing home sales were much weaker than forecast, Goldman Sachs economists lowered their Q2 GDP tracking estimate to 1.1 percent from 1.2 percent.

The 5.4 percent month-on-month decline in existing home sales in June, reported by the National Association of Realtors, was much weaker than the consensus expectation, the economists noted. The 4.37 million annualized rate of sales was also lower than expected despite upward revisions to the May sales figures.

Here come the downward U.S. GDP revisions again

It’s become an uncanny, almost seasonal pattern over the last few years: The economy perks up as a new year kicks into gear only to flail again by the time summer comes around.

It must be that time of year. A very weak U.S. retail sales report for June forced economists to again take an axe to their already meager forecasts for economic growth this year. Stephen Stanley at Pierpoint Securities, suggests the figures are beginning to dip dangerously close to contraction.

I have been near the bottom of the range of estimates on Q2 GDP for the last month or two and it seems like we are all chasing the data lower. Before today, I had about 1% for Q2 real GDP. The awful retail sales figures coupled with somewhat higher-than-expected inventories tally takes me down to +0.6%.

Fed doves ‘will not be patient’

Ellen Freilich contributed to this post

The Fed did the twist. Will it shout as well? There has been some debate among economists about whether the U.S. central bank might launch a third round of outright bond buys or QE3 given that it just prolonged Operation Twist.

But a truly grim report on the U.S. manufacturing sector from the Institute for Supply Management, if coupled with further evidence of a deteriorating labor market, could certainly induce policymakers to press their foot to the monetary accelerator.

Not only did the index slip below 50 in June, pointing to a contraction for the first time in three years, but the reading of 49.7 was lower than the lowest forecast in a Reuters poll of economists. Moreover, the subcomponents showed the biggest drop in new orders since the aftermath of the Sept. 11 attacks in 2001.

Repo market big, but maybe not *that* big

Maybe the massive U.S. repo market isn’t as massive as we thought. That’s the conclusion of a study by researchers at the Federal Reserve Bank of New York that suggests transactions in the repurchase agreement (repo) market total about $5.48 trillion. The figure, though impressive, is a far cry from a previous and oft-cited $10 trillion estimate made in 2010 by two Yale professors, Gary Gorton and Andrew Metrick. The Fed researchers, acknowledging the “spotty data” that complicates such tasks, argue the previous $10-trillion estimate is based on repo activity in 2008 when the market was far larger, and is inflated by double-counting.

Repos are a key source of collateralized funding for dealers and others in financial markets, and represent a main pillar of the “shadow” banking system. The market was central to the downfalls of Lehman Brothers and Bear Stearns in the 2008 crisis, and now regulators from Fed Chairman Ben Bernanke on down are looking for a fix. Earlier this year, the New York Fed itself said it might restrict the types of collateral in so-called tri-party repos, after being dissatisfied with progress by an industry committee.

The study published by the New York Fed on Monday slices the complex market into five segments, mapping the flow of cash and securities among dealers, funds and other players. Because dealers represent about 90 percent of the tri-party market, the Fed study extrapolates that onto the broader repo market, to arrive at its estimates. Bottom lines: U.S. repo transactions total $3.04 trillion; U.S. reverse repo transactions total $2.45 trillion.

MIT’s Johnson takes anti-Dimon fight to Fed’s doorstep

Simon Johnson is on a mission. The MIT professor and former IMF economist is trying to push JP Morgan CEO Jamie Dimon to resign his seat on the board of the New York Fed, which regulates his bank. Alternatively, he would like to shame the Federal Reserve into rewriting its code of conduct so that CEOs of banks seen as too big to fail can no longer serve.

Asked about Dimon’s NY Fed seat during testimony this month, Bernanke argued that it was up to Congress to address any perceived conflicts of interest.

But Johnson says the Fed itself should be trying to counter the perception of internal conflicts. He told reporters in a conference call:

BoEasing

The Bank of England is finally catching a break. With Britain’s economy officially in recession, the BoE had been constrained from further monetary easing by a stubbornly high inflation rate. But as the global economy stumbles and Europe’s crisis rages unabated, UK price pressures may be giving way.

Barclays economist Chris Crowe argues:

We expect the MPC to announce an additional £50bn in QE at the July policy meeting.

CPI inflation fell to 2.8% y/y in May (Barclays 3.1%, consensus 3.0%) from 3.0% in April. Meanwhile, RPI inflation declined to 3.1% y/y (Barclays and consensus 3.3%), from 3.5%. With near-term inflationary pressures easing, the case for additional QE in response to faltering confidence is stronger.

Get ready for QE3 if things don’t get better soon

Ben Bernanke appears to be reluctantly gearing up for a third round of large-scale Federal Reserve bond buying, so-called QE3. Millan Mulraine of TD Securities captures just how likely further monetary easing is becoming following the Fed’s decision on Wednesday to expand Operation Twist.

The burden of proof may now be on the incoming data to prove that a third round of large-scale asset purchases may not be necessary.

Just under two months before the central bank’s yearly gathering at Jackson Hole – where Bernanke announced QE2 – the Chairman emphasized the path of the job market will be a key driver of any decision to further expand the central bank’s $2.8 trillion balance sheet. He told reporters at a press conference: