MacroScope

Show and tell: Fed’s balance sheet not as big as you thought

Size matters, and Federal Reserve’s balance sheet is not as big as shrill critics of QE3 would lead you to believe.

True, $3 trillion is serious money. It represents a tripling in the size of the Fed’s balance sheet since 2008, before the U.S. central bank unleashed the first round of its aggressive campaign of so-called quantitative easing. It is now on round three, and has committed to keep buying bonds until it spies a substantial improvement in the outlook for the labor market.

But as a percentage of GDP (gross domestic product), the Fed’s balance sheet is still smaller  than those of the Bank of Japan, European Central Bank, and Bank of England, notching under 20 percent of GDP compared with over 30 percent of GDP for both the BOJ and ECB.

Jim Bullard, president of the St. Louis Federal Reserve, made this point during a presentation at Mississippi State University on Wednesday. The graph on page 32 of his slideshow tells the tale.

Bullard was more cagey on whether it mattered that the Fed’s balance sheet was smaller than several other major central banks. He said the size of the balance sheet could still hinder a “graceful exit” from the Fed’ extraordinary efforts to spur growth, while the value of the assets on its books would fall as interest rates rise. However, if investors decide to really start worrying about central bank balance

Don’t fear inflation boogeyman: BofA’s Harris

Worries about potential side-effects of unconventional monetary policy on financial markets are at least exaggerated, if not a near figment of the imagination.

This appears to be the conclusion of a comprehensively-argued research note by Bank of America Merrill Lynch global economist Ethan Harris.

The risk investors need to focus on is disinflation, not inflation; yet, remarkably, over the last several years critics of the Federal Reserve’s quantitative easing have “hijacked” the inflation debate, Harris says.

QE3 debate kicks into high gear: Get ready for an assembly line of Fed speeches

Is it full steam ahead for the Fed’s QE3 or is the U.S. central bank having second thoughts? Next week’s veritable assembly line of speeches from Fed officials could help answer that question. Vice Chair and possible Bernanke successor Janet Yellen kicks off the week with remarks to an AFL-CIO conference. She is followed by numerous regional Fed presidents, the bulk of them with hawkish tendencies: Esther George, Jeffrey Lacker, Charles Plosser and Dennis Lockhart on Tuesday, St. Louis’ James Bullard on Wednesday and Thursday, and finally, Cleveland Fed President Sandra Pianalto Friday. Oh, and the Fed’s regulatory point person, board governor Daniel Tarullo, testifies before the Senate Banking Committee on Thursday. The topic is a now-perennial one: “Wall Street Reform.”

 

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.

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:

Big government kept a “contained depression” from being a Great one: Levy

David Levy says he is bullish on the U.S. economy long term. But for now, the country is effectively stuck in a “contained depression,” the chairman of the Jerome Levy Forecasting Center told Reuters during a recent visit to our Washington bureau.

Still, things could have been much worse, says the third generation economist. For Levy, the interventions of a large and proactive federal government prevented a repeat of the 1930s.

In this corrective process, the reason we haven’t had a collapse in profits as we had in the Great Depression is we have – what nobody seems to like very much – a big government that’s stabilizing it by just simply running these deficits and being a much more active lender of last resort.

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.