MacroScope

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:

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.

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.

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.

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.

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.

The governor of the Bank of Japan, Masaaki Shirakawa, says he is confounded by the still very low level of Japanese government bond yields given the country’s elevated debt to GDP ratio of over 200 percent. Speaking on an IMF panel over the weekend, he offered a rather unintuitive explanation for the phenomenon:

It seems difficult to explain the case of Japan in light of conventional wisdom. One frequently offered explanation is that the ample domestic savings in Japan have absorbed the issuance of JGBs and the share of JGBs held by foreign investors is very small. But a more fundamental explanation is that the stability in the current bond yields reflects market participants’ expectations that fiscal soundness will be restored through structural reforms imposed in the economic and fiscal areas.

Most economists think Japanese yields are low because of continued expectations for deflation and weak economic growth. But for Shirakawa, it seems, it is public confidence in future fiscal restraint that is keeping bond yields low. Except he then contradicts this point by saying weak confidence in future fiscal reforms is also simultaneously undermining consumer spending:

It was fun to watch. Nouriel Roubini, NYU economist and crisis personality, was one of just five carefully selected individuals at a large gathering in the International Monetary Fund HQ1 building’s towering atrium who actually got to ask questions of the policymakers on stage.

Roubini was characteristically biting in his critique of conventional orthodoxy, singling out the European Central Bank for not having done enough to stem the euro zone’s two-year financial crisis. He challenged the notion that the ECB is powerless to boost growth further, suggesting — to the clear discomfort of some policymakers in the room — that measures to weaken the currency could provide a badly-needed boost to exports:

I saw that on the panel there are four central bankers and the panel is about fiscal policy and sovereign debt. So the natural question is then to think maybe about what could be the contribution of central banks in resolving sovereign debt issues. Now, one simple answer would be to just monetize very large budget deficits and I understand why a central bank would say that’s a no-no.

Central bankers have said repeatedly since the start of the global financial crisis that monetary policy can only do so much to heal a broken economy. Agustín Carstens, president of Mexico’s central bank, chose an interesting analogy at an IMF event this weekend to describe the adjustment needed in countries with very high debt levels:

In relatively modern cars the spare tire is (pretty small). Basically that spare tire should be enough to take you to the next gas station. But if you want to drive your car (a very long distance) it’s likely you will never get there.

So today I think what central banks have done is that the tire was gone, they used the spare tire, the spare tire is this big, and you can go just a few miles to the next gas station and you repair the car. So, if they (the fiscal authorities) don’t do that then they will be left on the road.

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.