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.
In QE3 waltz, Fed again steps toward easing
On again, off again. That’s been the story with prospects for another round of monetary stimulus from the Federal Reserve. Expectations for a third installment of quantitative easing, the much-debated QE3, had ebbed with improving economic data in the first quarter – but are now flowing anew.
Following a weak employment report for last month, the latest hint that more bond buys could be in the offing came from minutes of the central bank’s April meeting, which saw the Fed leave rates near zero and repeat that it would likely hold them there until at least late 2014. Policymakers appeared to be taking an increasingly dim view of economic prospects given an array of looming threats to growth, even if none are particularly new.
According to the minutes:
Participants identified several downside risks to the projected pace of economic expansion, including the fiscal and financial strains in the euro area and the possibility of an abrupt fiscal consolidation in the United States.
To Millan Mulraine at TD Securities, the more negative tone suggested a modestly greater inclination to lean in the direction of easing. In particular, Mulraine singles out this sentence in the minutes:
Several members indicated that additional monetary policy accommodation could be necessary if the economic recovery lost momentum or the downside risks to the forecast became great enough.
Writes Mulraine:
Last week, the Brits reached the same conclusion I did a year ago: that we’ve reached the point of diminishing returns with QE. The pain from QE-motivated inflation is as damaging as the benefit from stocks rising (wealth effect?)
Hence: There should not be a QE3.
What happens when Operation Twist ends in June 2012? Will Ben launch QE3 during this year’s Jackson Hole conference? I sincerely hope not.
In this country, the central bank (The Federal Reserve) has a dual mandate (since 1978):
full employment
stable prices (read as low inflation)
That’s a short list. Conspicuously absent from that list is a mandate to:
-encourage speculation,
-drive the stock market higher,
-punish investors reliant upon income or that are otherwise unwilling to place a large portion of their life savings in the Vegas-like machine that is the US stock market,
- foment international unrest from a drop in value of the US dollar.
It is true that QE1 played a very significant role in stopping an economic collapse in 2009, and that it spurred another sugar-rush unsustainable stock market rally (is that what prosperity is?). But there was no free lunch. QE1 managed to reverse the deflationary forces taking hold of the economy, but it also significantly debased the value of the US dollar. This in turn meant the most significant export of the United States became inflation.
QE2 took over where QE1 left off:
-another risk-on unsustainable purely speculative stock market rally,
-high quality bonds lost value again (penalizing those that were defensive and conservative),
-interest rates rose on consumer loans and mortgages,
-food and fuel inflation spiked in the US and globally. In no small part, QE2 helped induce the “Arab Spring”.
Launching QE3 might provide yet another sugar-rush stock market rally (though probably smaller). But whatever the perceived gain might be, it would be counter-balanced by the detrimental effects of heightened food and fuel inflation, and higher interest rates courtesy of foreign buyers of US Treasury bonds balking at our printing press efforts. Surely the point of diminishing returns was reached with QE2.
Conventional monetary policy tools seem to have worked in rectifying previous recessions. A case could potentially be made to launch QE3 if it were obvious we were in a classic business cycle recession and that one more dose of monetary steroids might cure the ailment (not merely mask the symptoms). But it is clear we were not (2007-2009) and are not now in a business cycle recession. Rather, we have been and are in a much more challenging type of recession: a balance sheet recession. The best that can be hoped from monetary policy tools in a balance sheet recession is they act as an expensive snooze button. The systemic economic issues don’t go away. They merely wait to be addressed. But the cost of the most recent monetary policy tools (QE1 & QE2) are such that they’ve added to the systemic problem by increasing our public debt. It turns out you can’t solve a debt problem with more debt.
Let’s briefly look at what joint myopic monetary and fiscal policy intrusion has delivered over the past 12 years:
A recession in year 2000. 18 years of overspending and irresponsible myopic fiscal policy was beginning to take a toll. Arguably, we should have taken our medicine then. But no. Monetary and fiscal steroids were the prescription. The S&P500 lost 47% as demand collapsed. The Fed dropped short term rates to 1% in response. The US Congress & White House gave us unfunded tax cuts for a decade and introduced a massive new unfunded healthcare liability (medicare part D). The result was predictable: an artificial bubble in risk and leveraged assets (the stock market, the housing market). A colossal mis-allocation of resources and waste of several years. The problem was made larger and delayed for someone else to deal with (kick the can).
A recession recurred in 2008-2009 when the eventual housing and stock market bubble burst. The S&P500 lost 57%. This time it took 0% interest rates, QE1, QE2, $ Trillions in US bailouts and Keynesian fiscal policy stimulus (spending beyond our means), and a stream of sovereign bailouts in Europe that remains unresolved. The snooze button again.
Another US recession will likely begin in mid 2012 (June?). Early 2012 sees the S&P500 all the way back up to where it was 12 – 13 years ago. Worse, there is a very good chance stock markets will fall through the March 2009 lows. Why shouldn’t they ? Are the economic prospects that much better than they were 4 years ago?
There should not be a QE3 or any other monetary policy intrusion. Our three decade debt binge needs to be worked off. This position necessarily means the US and most world economies will head into the worst recession since the 1930s. But more monetary policy tricks will only add to the problem.
The last time we saw a balance sheet recession was the 1930s. We know what came next: WWII. Let us try to avoid the same mistakes. Ben, avoiding WWIII may not be part of the Fed’s mandate. But it should be.
Jobs or inflation — Is the Fed distracted?
The Federal Reserve doesn’t get much love from Washington these days but it did receive a rare bit of political backing on Wednesday as Democrats defended its role in promoting full employment as well as stable prices.
The U.S. central bank has been the target of criticism from members of both political parties as a result of bank bailouts and hands-off rule-enforcement that let predatory and unsound lending practices go unchecked, among other shortfalls.
But discussing legislation narrowing the Fed’s mandate to a single-minded focus on price stability, Democrats questioned the need to drop the full employment side of the dual mandate.
“Is it a problem?” asked Minnesotan Keith Ellison. “To the degree that we have problems with monetary policy, is the dual mandate the cause?”
Ellison said that far from distracting the Fed, the lofty 8.1 percent unemployment rate should get greater attention. “This is a national disgrace,” he said.
Ron Paul, a presidential candidate who chairs a subcommittee on domestic monetary policy, held a hearing to discuss several pieces of legislation changing the Fed’s mandate. Two of these would limit the Fed’s focus to price stability.
With partisan divisions and other priorities, Congress is unlikely to make any changes to the Fed’s mandate this year. But the effort could gain momentum if Republicans control both houses of Congress after November.
The Feds don’t control credit unions, that’s why I moved my money. That and the fact that they actually pay you interest on your savings!
Fed’s Tarullo not making any promises
We’re pretty sure that Daniel Tarullo, the Federal Reserve’s point person on regulation, expects the United States will finally understand exactly what financial reforms are coming “some time next year.” But the Fed governor made doubly sure to qualify that statement lest anyone – especially any press “in the back” – take it as gospel.
At a conference in New York Wednesday morning, Tarullo was asked how long it would take for the various regulatory agencies to give final details on the raft of financial crisis-inspired reforms, everything from Basel III capital standards to the Volcker ban on proprietary trading. Here’s what he said:
“I know it’s frustrating for people not to have the proposed rules out. On the other hand, doing them simultaneously does allow us to see whether something in one of the proposed capital rules will affect something in another proposed capital rule, so that we end up, when we publish the final rules, with fewer anomalies, questions and the like, which will undermine the ability of a firm or academic or just anyone in the public to see and understand how these things are going to function. I hesitate to give a time line on exactly when we’ll get there. But I think…it seems to be reasonable to expect that some time next year the basic outlines – and I don’t just mean the ideas, I mean the details associated with the major reform elements – should be reasonably clear to people even though questions will inevitably rise in implementation. (You) don’t want to take that as a promise. But as I think about these various streams, that is my expectation… To have gotten it done this year would have meant the sheer magnitude of the task would have lead to a lot of inconsistencies or open questions, which then would have just produced another round of change. So you’ve got me on the record saying some time next year, but I tried to qualify it as much as possible – that’s for all you people in the back…”
Put your rate hike where your mouth is
Jonathan Spicer and Van Tsui contributed to this post.
This week, for the second time ever, the U.S. Federal Reserve published policymakers’ forecasts for when the central bank should start raising rates. The chart suggested a split Fed, with three policymakers expecting a rate rise this year, three next year, seven in 2014 and four in 2015. That’s useful information, as far as it goes.
But as much as the Fed has embraced transparency in recent years, it stopped short of saying which policymaker backs a rate hike in which year – a key bit of data for grasping where the voters on Fed Chairman Ben Bernanke’s policy-setting committee stand, and how their positions shift over time.
Below is the bar graph that the Fed published Wednesday, with Reuters’ best estimates of who fell where. We stand ready be convinced otherwise by readers offering evidence or insight that supports a different view. Send us an email, gives us a call, write a comment or shout us out on Twitter.
You can find more information about the policy leanings of each top Fed official in our handy interactive hawks-doves chart.
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.
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.
A cleaner, meaner hawks-doves chart
Fed officials have been out giving speeches in full force lately, with no less than six policymakers taking to the podium on Thursday alone. The latest, most up-to-date incarnation of our handy interactive hawks-doves chart can help you make sense of it all. Thanks to Van Tsui and the rest of the Reuters Graphics team for their great work.
