MacroScope

Two Fed financial stress measures show conditions still easy

Composure restored. Despite gut-clenching stock market swoops and a violent 100 basis point upward spike in 10-year bond yields since the Fed’s June 19 meeting and press conference with Chairman Ben Bernanke, financial conditions are still very easy.

That ought reassure officials at the U.S. Federal Reserve that some normalcy has been restored in financial markets after the abrupt reaction to their decision to signal they would scale back bond purchases later this year.

A persistent upward scramble in yields and mortgage rates could chill spending and investment, potentially undermining economic recovery.

Good news then from the Chicago Fed’s weekly barometer, which showed conditions creeping up in the week to July 5 from a measure of -0.69 from -0.71 the week before, but still well away from territory that would signal real stress. Positive values show conditions are tighter than average and while negative values are looser.

Meanwhile, a separate monthly index from the Kansas City Fed edged to -0.45 in June from -0.65 in May, its seventeenth consecutive month below the long-run average.

Fear the Septaper

Credit to Barclays economists for coining the term ‘Septaper’

A solid U.S. employment report for June appears to have cemented market expectations that the Fed will begin to reduce the pace of its bond-buying stimulus in September.  Average employment growth for the last six months is now officially above 200,000 per month.

Never mind that, even at this rate, it would take another 11 months for the job market to reach its pre-recession levels – and that’s not counting the population growth since then.

John Brady, managing director at R.J. O’Brian & Associates in Chicago, nails the market’s sentiment:

Full blown damage control?

Call it the great wagon circling.

Central bankers are talking tough in the face of the wild gyrations in financial markets. But it’s becoming increasingly clear they are sweating – and drawing up contingency plans to assuage the panic that’s taken hold since Chairman Ben Bernanke last week sketched out the Fed’s plan for winding down its QE3 bond-buying program. U.S. policymakers in particular must have predicted investors would react strongly. But now that longer-term borrowing costs have spiked to near a two-year high, they look to be entering full-blown damage control.

Here’s Richard Fisher, head of the Dallas Fed, speaking to reporters in London on Monday:

I’m not surprised by market volatility – markets are manic depressive mechanisms… Collectively we will be tested. We need to expect a market reaction… Even if we reach a situation this year where we dial back (stimulus), we will still be running an accommodative policy.

In his own words: Fed’s Bullard explains dovish dissent

The following is a statement from the St. Louis Fed following the decision by its president, James Bullard, to dissent from the U.S. central bank’s decision to signal a looming reduction in its bond-buying stimulus program:

Federal Reserve Bank of St. Louis President James Bullard dissented with the Federal Open Market Committee decision announced on June 19, 2013.  In his view, the Committee should have more strongly signaled its willingness to defend its inflation target of 2 percent in light of recent low inflation readings.  Inflation in the U.S. has surprised on the downside during 2013.  Measured as the percent change from one year earlier, the personal consumption expenditures (PCE) headline inflation rate is running below 1 percent, and the PCE core inflation rate is close to 1 percent.  President Bullard believes that to maintain credibility, the Committee must defend its inflation target when inflation is below target as well as when it is above target.

President Bullard also felt that the Committee’s decision to authorize the Chairman to lay out a more elaborate plan for reducing the pace of asset purchases was inappropriately timed.  The Committee was, through the Summary of Economic Projections process, marking down its assessment of both real GDP growth and inflation for 2013, and yet simultaneously announcing that less accommodative policy may be in store.  President Bullard felt that a more prudent approach would be to wait for more tangible signs that the economy was strengthening and that inflation was on a path to return toward target before making such an announcement.

Bernanke’s seven-percent solution

 

Federal Reserve Chairman Ben Bernanke has a problem: how to wean markets from dependence on central bank stimulus. On Wednesday Bernanke did what some of his most dovish colleagues have urged for months. He laid out a clear path for how and when the Fed will bring its third round of bond-buying to a close.

It doesn’t take a master detective to figure out his solution – 7 percent.

“If the incoming data are broadly consistent with this forecast, the committee currently anticipates that it will be appropriate to moderate the monthly pace of purchases later this year, and if the subsequent data remain broadly aligned with our current expectations for the economy, we will continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around mid-year,” Bernanke said in a press conference following the Fed’s two-day policy-setting meeting.

“In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains.”

Why low inflation may not prevent the Fed from reducing QE

Everybody knows U.S. unemployment, currently at 7.6%, is still too high – especially the millions of Americans struggling to find work. Less widely acknowledged is a recent dip in inflation that puts it well below the Federal Reserve’s 2 percent target. Indeed, at 0.7 percent in April, the Fed’s preferred inflation measure was less than half of the central bank’s explicitly stated goal. So why are Fed officials, gathered in Washington for their latest policy decision today, discussing a pullback in stimulus rather than an increase in it?

According to some economists, it’s because policymakers believe the recent decline in inflation will be transitory and that the rate will gradually move back up toward target as growth picks up during the rest of this year and in 2014. Yesterday’s report on consumer prices corroborated that prospect for some analysts.

Paul Ashworth, chief US economist at Capital Economics, wrote:

The low level of headline inflation largely reflects the drop back in commodity prices over the past 12 months, with even the low core rate partly explained by the indirect impact of those lower commodity prices. Under those circumstances, we wouldn’t expect the Fed to put too much weight on inflation being below its target. Once commodity prices level out, the downward pressure on consumer goods prices will begin to ease. In other words, this won’t prevent the Fed from beginning to reduce its monthly asset purchases, probably beginning in September.

The chairman’s challenge: Bernanke says ‘taper,’ markets hear ‘tighten’

For a central bank that likes to tout the importance of clear communication, the Federal Reserve sure knows how to be obtuse when it wants to. Take Bernanke’s testimony before the Joint Economic Committee of Congress last month. His prepared remarks were reliably dovish, emphasizing weakness in the labor market and offering no hint of an imminent end to the current stimulus program, which involves the monthly purchase of $85 billion in assets.

It was during the question and answer session that the real fireworks came. Asked about the prospect for curtailing such bond buys, Bernanke said:

If we see continued improvement and we have confidence that that’s going to be sustained then we could in the next few meetings … take a step down in our pace of purchases. If we do that it would not mean that we are automatically aiming towards a complete wind down. Rather we would be looking beyond that to see how the economy evolves and we could either raise or lower our pace of purchases going forward.

What’s a Fed to do? Taper talk persists despite missed jobs, inflation targets

As the Federal Reserve meets this week, unemployment is still too high and inflation remains, well, too low. That makes some investors wonder why policymakers are talking about curtailing their asset-buying stimulus plan. True, job growth has averaged a solid 172,000 net new positions per month over the last year, going at least some way to meeting the Fed’s criteria of substantial improvement for halting bond purchases.

So, either policymakers see brighter skies ahead or they want to get out of QE3 for other reasons they may rather not air too publicly: worries about efficacy or possible financial market bubbles.

“I don’t think the data dependent emphasis is the only ball the Fed is focusing on when mulling over the pace and extent of asset purchases,” says Thomas Lam, chief economist at OSK-DSG.

What’s in a (trend payrolls) number? The Chicago Fed paper that shook the markets, ever so slightly

      

Ann Saphir contributed to this post

The apparent conclusion from one of the most dovish regional Federal Reserve banks was rather surprising: The economy may actually need much smaller monthly job growth, of around 80,000 or less, in coming years in order for the jobless rate to keep moving lower. The immediate policy implication, it might seem, is that the U.S. central bank may have to tighten monetary policy much sooner than previously thought.

Andrew Brenner of National Alliance remarked that, while the report should be taken with a grain of salt, “this translates to lowering the bar to QE tapering.”

Right? Not necessarily, writes Goldman Sachs economist Jan Hatzius. Here’s why:

Forget the ‘wealth effect’: real wages drive U.S. consumer spending

 

Federal Reserve officials have touted the ‘wealth effect’ from higher stock prices and rising home values as a key way in which monetary policy boosts consumer spending and economic activity. But according to the results of a recent survey from the Royal Bank of Canada, that ethereal feeling of being richer on paper is no substitute for cold, hard cash.

Here’s how Fed Chairman Ben Bernanke explained the benefits of rising asset prices to the real economy during a press conference in September.

The tools we have involve affecting financial asset prices and those are the tools of monetary policy. There are a number of different channels – mortgage rates, I mentioned corporate bond rates, but also prices of various assets, like for example the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they’ll feel more disposed to spend. If house prices are rising people may be more willing to buy homes because they think that they will make a better return on that purchase. So house prices is one vehicle.