MacroScope

From one central banking era to another: beware the consequences

Paul Volcker’s inflation-fighting era as chairman of the Federal Reserve is quite the opposite of today’s U.S. central bank, which is battling to kick start growth and even stave off deflation with trillions in bond purchases. And it is polar opposite of where the Bank of Japan finds itself today, doubling down on easing to lift inflation expectations after two decades of Japanese stagnation. After all, Volcker ratcheted up interest rates in 1979 and the early 1980s to tame the inflation that had been choking the United States.

So it may come as no real surprise that, talking to students and faculty at New York University on Monday, he had a few concerns about where the world’s ultra accommodative central banks are headed.

“There are going to be big losses at central banks at someplace along the line,” he said. “You do all this support of buying longer term securities at very low interest rates; long term interest rates aren’t going to stay where they are forever; at some point losses are going to be taken.”

For the Fed, the BoJ, the European Central Bank and the Bank of England, he said, the money-printing will inevitably raise questions about limiting activities of central banks. “These central banks are no longer central banks. The Federal Reserve is the world’s biggest financial intermediary, it is dominating the long term credit market in the United States, and it is dominant in the residential mortgage market…” he said.

Volcker had particular words for the BoJ, which aims to raise inflation expectations to 2 percent within 2 years. It might be an “illusion” that inflation targets can be lowered again once the economy looks better, he said. “Once that feeling gets in there that a level of inflation is a good idea for the economy, it is very hard to get rid of.”

France’s downturn is more significant than you think

The huge downturn in French businesses was by far the most disappointing aspect of this week’s euro zone PMIs, which again painted a dismal picture of the euro zone economy.

Maybe it’s because grim euro zone PMIs come around with depressingly familiarity these days, but economists on the whole had surprisingly little say about this.

Still, the March survey delivered some major landmarks relating to France.

Most obviously, its services companies endured their worst month since February 2009, practically at the nadir of the Great Recession of 2008-09.

Goal line on jobs still a long way off: former Fed economist Stockton

The Great Recession set the U.S. labor market so far back that there is still a long way to go before policymakers can claim victory and point to a true return to healthy conditions, a top former Fed economist said. The U.S. economy remains around 3 million jobs short of its pre-recession levels, and that’s without accounting for population growth.

“The goal line is still a long ways off,” David Stockton, former head of economic research at theU.S.central bank’s powerful Washington-based board, told an event sponsored by the Peterson Institute for International Economics. He sees the American economy improving this year, but believes the recovery will continue to have its ups and downs.

A lot of people have been quite excited about some of the recent strength in the labor market. It’s encouraging but I don’t think we’ve yet seen any clear break out and I don’t think we’re going to for a while.  […]

Investors call for interest rate hike in Brazil

Two analyses published this week highlight how alarmed investors are about inflation in Brazil.

In the first, published on Wednesday following a poll on global stock markets, equity investors say an interest rate hike wouldn’t be a bad idea – a paradox, since stocks usually drop when borrowing costs rise. Are they keen to move to bonds? Not really; their argument is that an interest rate hike could assuage inflation fears after eight consecutive months of above-forecast price rises. A rate hike could also reduce concerns of economic mismanagement after several government attempts to intervene in key sectors such as banking and power generation.

The central bank signalled it could act later this year, but would rather wait because the recent inflation surge could be just temporary. Bond investors disagree, according to a separate analysis published today. In their view, inflation will remain above the 4.5 percent target mid-point through at least 2018, raising uncertainty about long-term investments needed to bridge the gap between Brazil’s booming demand and its clogged roads and ports.

Is Slovenia the next shoe to drop?

The Cypriot saga has thrown the spotlight on Slovenia, which is also a small euro zone country struggling with an over-burdened banking sector.

Slovenia’s mostly state-owned banks are nursing some 7 billion euros of bad loans, equal to about 20 percent of GDP, underpinning persistent speculation that the country might have to follow other vulnerable euro zone countries in seeking a bailout.

According to Standard Bank’s head of emerging market research Tim Ash:

The latest crisis in the euro zone, this time in Cyprus, continues to raise questions as to possible contagion effects throughout the region, and in particular which economies could be next.

Rip-off Britain on the line

For all the talk about imported inflation in the UK as policymakers talk down the pound and financial markets merrily give it a good beating, here’s a stark reminder that a lot of British inflation remains home-grown.

British inflation has been so sticky over the past decade that regular Bank of England pronouncements that it will come back down from wherever it is to the 2 percent target at the 2-year horizon has become something of a policy piñata in financial markets. And there is rampant speculation the government will soon modify that inflation target.

But it’s no joke to British consumers, whose wages have stagnated for years and with a plunging currency in their pocket that is down more than 8 percent so far this year. They’ve been much more frugal with their spending, and as a result the economy is on its back.

Another U.S. debt ceiling showdown could roil markets: NY Fed paper

After two days of testimony from Federal Reserve Chairman last week in which he decisively criticized Congress’ decision to slash spending arbitrarily in the middle of a fragile economic recovery, a report on money market funds from the New York Fed nails home the point.

The paper’s key finding is that, as most observers already knew, investors were a lot more worried about a break-up of the euro zone in the summer of 2011 than they were about U.S. congressional bickering over the debt ceiling.

But as Americans face a series of regularly schedule mini-eruptions in the fiscal policy arena, the authors conclude with a thinly-veiled warning to lawmakers:

Bernanke: The quickest way to raise rates is to keep them low

That’s not a typo in the headline. In a recent speech that took some mental gymnastics to absorb, Federal Reserve Chairman Bernanke countered critics of his low rates policy by arguing that a loose monetary policy is the best way to ensure rates can rise to more normal levels.

Why? Because interest rates will naturally move higher once stronger economic growth leads to higher rates of return on investment, Bernanke said. Here’s his argument:

One might argue that the right response to these risks is to tighten monetary policy, raising long-term interest rates with the aim of forestalling any undesirable buildup of risk. I hope my discussion this evening has convinced you that, at least in economic circumstances of the sort that prevail today, such an approach could be quite costly and might well be counterproductive from the standpoint of promoting financial stability. Long-term interest rates in the major industrial countries are low for good reason: Inflation is low and stable and, given expectations of weak growth, expected real short rates are low. Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading–ironically enough–to an even longer period of low long-term rates. Only a strong economy can deliver persistently high real returns to savers and investors, and the economies of the major industrial countries are still in the recovery phase.

Hey brother, can you spare a coupon?

Remember those green shoots? Ever since Fed Chairman Ben Bernanke uttered those words in response to the first signs of recovery from the Great Recession in 2009, many forecasters – including Fed officials – have consistently overestimated the economy’s strength.

Some economists believe 2013 could finally be a break-out year. With the fiscal cliff now in the rear-view mirror and the euro zone crisis apparently stabilized, some see the prospect that growth could actually exceed expectations for the first time in a long while.

Dennis Lockhart, president of the Atlanta Fed, said this week he sees a chance the economy might actually surpass his 2013 growth forecast range of 2-2.5 percent.

Bullard weighs in on his colleague’s challenge to the ‘Bernanke doctrine’

Earlier this month, Fed Governor Jeremy Stein made waves that are still rippling with a speech on the risks of credit bubbles. The policymaker said that the U.S. central bank could use interest rates, as opposed to the more conventional tool of regulation, to cool overheating in junk bonds and other markets.

With worries growing that the Fed’s easy-money policies are inflating dangerous bubbles in financial markets, the speech could portend an earlier-than-expected reversal of quantitative easing or raising of ultra low rates. But don’t take my word for it. Here’s what St. Louis Fed President James Bullard had to say about Stein’s speech, when he visited New York University last week:

“My main takeaway from the speech … was that he pushed back against the Bernanke doctrine. The Bernanke doctrine has been that we’re going to use monetary policy to deal with normal macroeconomic concerns, and then we’ll use regulatory policies to try to contain financial excess. And Jeremy Stein’s speech said, in effect, I’m not sure we’re always going to be able to take care of financial excess with the regulatory policy. And in a key line he said, raising interest rates is a way to get into all the corners of the financial markets that you might not be able to see, or you might not be able to attack with the regulatory approach. So I thought this was interesting. And I would certainly think that everybody should take heed of this. This is an argument that, maybe you should think about using interest rates to fight financial excess a little more than we have in the last few years.”