MacroScope

Fed speaks, but does market listen?

Jonathan Spicer contributed to this post

When the Fed adopted thresholds for its low interest-rate policy last December, Fed Chairman Ben Bernanke said they would make “monetary policy more transparent and predictable to the public.” But now that the policy is fully in place, it doesn’t seem that the public and the Fed are predicting the same thing at all. Not even close.

In their policy statement following a two-day meeting that wrapped up Wednesday, Fed policymakers removed any reference to date-based policy guidance, saying only that exceptionally low rates would remain in place as long as unemployment remains above 6.5 percent and inflation is not seen to top 2.5 percent. But as recently as December, the Fed’s statement suggested policymakers did not believe those thresholds would be met until at least mid-2015.

The market, as personified by traders ofU.S.short-term rate futures at the Chicago Board of Trade, believes differently. According to CME Group’s FedWatch, which uses fed fund futures prices to estimate market expectations, traders were pricing in a 55 percent chance of a first rate hike by October 2014 – eight months before the Fed’s forecast last month. Threshold-based policy does not seem to have brought the market and the Fed onto the same page – not even to the same year.

Craig Dismuke, chief economic strategist at Memphis-based broker-dealer ViningSparks, has an explanation. “The minutes from the December meeting, where some are thinking about trying to end asset purchases earlier than expected – I think there’s this idea that there’s a little more hawkishness to the Fed than some people thought maybe at the beginning of December,” he said.

In addition, inflation expectations, as measured by trading in 5-year inflation-protected bonds, have risen over the past month. ”As those inflation expectations go up, which I think is natural as the economic data looks better, people are moving in their belief of how long the Fed can sit on the sidelines. You have to price in a greater likelihood that inflation begins to rise sooner. I think that’s what’s happening.”

Will the Fed adopt thresholds for bond buys?

Tim Ahmann contributed to this post

Suddenly top Wall Street firms are talking about the possibility that the Fed might adopt numerical thresholds for asset purchases, in the same way it has done with interest rates more broadly.

Writes Mike Feroli, chief economist at JP Morgan and a former NY Fed staffer:

Perhaps the most interesting element of Fed policy at the current juncture is how they communicate the conditions that will lead to a slowing or a halt in asset purchases. The speed with which the Committee produced the numerical threshold rate guidance is a reminder that the Bernanke Fed can get their homework done early, but even so we do not look for any news on this front next week.

First, the discussion of this topic is still in its infancy; even the numerical threshold guidance took a few months of debate to finalize. Second, since the introduction of the Chairman’s press conference the FOMC has shown a strong preference to make big decisions – and ones potentially subject to public misunderstanding – at meetings associated with a press conference. There is no press conference scheduled for next week’s meeting. Third, given the complicated task of quantifying the costs of balance sheet expansion, it’s not even certain the Fed will ever communicate the economic conditions that would slow or stop their asset purchases.

Goldman hones in on Fed statement watchword: “Initially”

It’s that time again: Fed watchers are already parsing possible changes to the January policy statement, even before it is released. Goldman Sachs economists in particular have identified one passage ripe for some type of tweak — one that could signal the appetite for continued bond buys:

With Treasury purchases under the new regime already underway, the statement that Treasury purchases would ’initially’ occur at a pace of $45 billion per month will have to be adjusted. If ‘initially’ is replaced with another modifier such as ‘at the present time’ rather than deleted, it would suggest downside risks to the size of     the Treasury program later this year.

From one Fed dove to another: I see your logic

Narayana Kocherlakota, the head of the Federal Reserve Bank of Minneapolis, has made a habit of turning economists’ heads. In September, the policymaker formerly known as a “hawk” surprised people the world over when he suddenly called on the U.S. central bank to keep interest rates ultra low for years to come. This week, Kocherlakota arguably went a step further into “dovish” territory, saying the Fed needs to ease policy even more. He wants the Fed to pledge to keep rates at rock bottom until the U.S. unemployment rate falls to at least 5.5 percent, from 7.8 percent currently – despite the fact that, just last month, the central bank decided to target 6.5 percent unemployment as its new rates threshold.

Kocherlakota’s bold policy stance is probably even more dovish – ie.  more willing to unleash whatever policies are needed to get Americans back to work – than even those of Chicago Fed President Charles Evans and Boston Fed President Eric Rosengren, until now considered the stanchest doves of the central bank”s 19 policymakers.

So in an interview on Tuesday, Reuters asked Rosengren what he thought of Kocherlakota’s plan. Here’s what he had to say:

Who said what, when? An unofficial guide to Fed speak on QE3

U.S. Federal Reserve policymakers, fresh from a December decision to ramp up asset purchases to help push down borrowing costs, will this year train a sharp eye on jobs.

A “substantial improvement” in the labor market outlook is a prerequisite for ending the bond-buying program, known as QE3 because it is the Fed’s third quantitative easing program since the Great Recession.

Below is a look at top Fed officials’ views on the asset-purchase program, currently at a monthly $85 billion, as well their take on the Fed’s new vow to keep rates low until unemployment falls to at least 6.5 percent, as long as inflation does not threaten to breach 2.5 percent.

Japan finally takes Bernanke-san’s advice – 10 years later

This post was based on reporting by Leika Kihara in Tokyo

Japan has crossed the monetary rubicon: the government is actively intervening in the affairs of the central bank, pressuring it to more aggressively tackle a prolonged bout of deflation and economic stagnation. The Bank of Japan is expected to discuss raising its inflation target from the current 1 percent level during its next rate decision on January 21-22.

Overnight, a Japanese newspaper reported the finance ministry and the central bank were considering signing a policy accord that would set as a common goal not just achieving 2 percent inflation but also steady job growth.

Key Japanese policymakers played down the prospect of making the BOJ responsible for stable employment like the U.S. Federal Reserve, but said a 2 percent inflation target will be at the heart of a new policy accord with the central bank.

Bond market prices Fed out – but just wait ‘til the debt ceiling

U.S. government bonds sold off last week following December Fed meeting minutes indicating growing doubts inside the central bank about the effectiveness of quantitative easing. Yields on benchmark 10-year notes hit an eight month high of 1.975 percent on Friday, in part as investors priced out some of the Fed asset purchases traders had been counting towards the end of 2013.

Other forces were also at work. Markets were relieved that the ‘fiscal cliff’-related expiration of Bush-era tax cuts had been circumvented, and encouraged by some moderately better U.S.economic data. The S&P 500 closed the first week of the year at its highest in five years.

Still, as has erroneously been the case in recent years, talk of a bond bubble resurfaced.

Revenge of the Fed hawks – sort of

Gabriel Debenedetti contributed to this post

Federal Reserve officials appear to be getting cold feet. Having just announced an open-ended bond buying program in September and then broadening it in December, minutes from last month’s policy meeting suggested an increasing caution about additional monetary stimulus among the Federal Open Market Committee’s core of voting members.

Several (members) thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet.

That’s considerably quicker than investors had in mind. Stock and bond markets recoiled at the prospect.

Does the Fed need a new mandate?

Are the world’s top central bankers too paranoid about inflation? As the United States struggles to sustain a weak recovery while the euro zone and Japan face outright contractions in output, a number of economists have called for the monetary authorities to be less dogmatic about adhering tightly to low inflation targets.

Most prominently, IMF chief economist Olivier Blanchard has argued the Federal Reserve’s 2 percent inflation target is too low given the severity of the loss of employment and growth that followed the Great Recession of 2008-2009. Kenneth Rogoff, co-author of an oft-cited study of economic downturns following financial crises called “This Time is Different,” has also championed greater inflation tolerance.

Fed officials, including Chairman Ben Bernanke, have flatly declined to entertain the notion, arguing that the potential cost – a loss of hard-won inflation-fighting credentials – is too high. “We are not seeking higher inflation, we do not want higher inflation and we’re not tolerating higher inflation,” he told a February hearing in Congress.

‘Cliff’ deal is one part relief, one part frustration for Fed

When Federal Reserve Chairman Ben Bernanke was last in New York, he joked about his past research into the effect of uncertainty on investment spending. “I concluded it is not a good thing, and they gave me a PhD for that,” he said, drawing laughter from a gathering of hundreds of economists in a packed Times Square conference room.

Laughter probably wasn’t echoing through the halls of the U.S. central bank on Wednesday. Late on Tuesday, Congress struck a last-minute deal that only partially and temporarily avoids the so-called fiscal cliff. Bernanke and other Fed policymakers – frustrated that it took politicians so long to address tax and spending levels in the first place – were hoping Washington would agree to a bi-partisan, longer-term plan to narrow the country’s massive deficit with only modest near-term fiscal restraint. While no deal on taxes would have been far worse for the economy, the fact that Congress put off decisions on government spending and the debt ceiling for another two months simply prolongs the uncertainty that many feel is holding back investments by businesses and households.

“You basically continue this fiscal policy uncertainty that we have had for the past year or more,” said Roberto Perli, managing director of policy research at International Strategy and Investment Group. In a note to clients, Perli predicted that at best the fiscal cliff deal does not change the outlook for Fed policy, which for now consists of rock-bottom interest rates and $85 billion per month in asset purchases. But more likely, he wrote, it would lead to even more accommodation from the Fed since Republicans – smarting from a political defeat in the last few days – may prefer to let the “sequester” of large-scale spending cuts kick in as scheduled on March 1 rather than agreeing to a smaller reduction in U.S. debt. In that case, the Fed would respond by keeping rates lower for longer, perhaps through early 2016, or simply by ramping up the value of asset purchases under its quantitative easing program (QE3), Perli wrote.