MacroScope

from Rahul Karunakar:

A December taper: a chance to regain lost face?

Dear Fed,

You should taper in December and regain lost  face.

Signed,

A growing but vocal minority of economists

 

Even if the latest Reuters poll consensus still shows the Federal Reserve will wait until March before trimming its monthly bond purchases, the clamor to do that in December - or rather later today - is rising.

Thirteen of 69 economists in the latest Reuters poll, almost one-in-five, now expect the Fed to start rolling back on their bond purchases in December: a sharp increase from the three of 62 in the previous poll.

Those economists forecasting the Fed to act on Wednesday said it would be a chance for the U.S. Federal Reserve to redeem its credibility after wrong footing market predictions in September.

 

Christopher Low, chief economist at FTN Financial
"The Fed lost credibility when, in May and again in June, Bernanke prepared the markets for tapering in a few months only to pass on a taper in July and September,"
"Tapering in December is supported not only by those at the Fed, like Esther George and Richard Fisher, who see it as good policy but also by some, like James Bullard and Jeremy Stein who see it as a way of repairing some the Fed’s damaged reputation."

 

Ever since Chairman Ben Bernanke's taper speech in May, financial markets have tried to second guess the timing of when the Fed would start reducing their monthly $85 billion of bond purchases, widely known as QE3, based on data releases.

A market-dependent Fed?

It’s hard to shake the feeling that the Federal Reserve is about to begin pulling back on stimulus not just on the back of better economic data, but also because financial markets have already priced it in. The band-aid ripping debate over an eventual tapering of bond purchases that started in May was so painful, Fed officials simply don’t want to go through it again.

If anything, recent data have been at best mixed, at worst worrisome. In particular, August job growth was disappointing and labor force participation declined further.At the same time, inflation remains well below the central bank’s objective.

Argues Dean Croushore, a former regional Fed bank economist and professor at the University of Richmond:

Obama’s second chance to reshape the Fed

Lost in the bizarre Yellen vs. Summers tug-of-war into which the debate over the next Federal Reserve Chairman has devolved, is the notion that President Barack Obama is getting a second shot at revamping the U.S. central bank.

The perk of a two-term president, Obama will get to appoint another three, potentially four officials to the Fed’s influential seven-member board of governors in Washington. This may buy the president some political wiggle room when it comes to his pick for Fed chair, since he might be able to placate Republicans with one or two “concession” appointments. Every Fed governor gets a permanent voting seat on the policy-setting Federal Open Market Committee.

Elizabeth Duke, the last George W. Bush appointee, is already on her way out. So is Sarah Bloom Raskin, who after a relatively short stint at the board is moving to the Treasury, to be Jack Lew’s Deputy Secretary. Then there’s the awkward suspicion that, if Obama passes up Fed Vice Chair Janet Yellen, by far the favorite for the top spot, she will also step down after a long career in the Federal Reserve system, including many years as head of the San Francisco Fed.

Loose lips sink ships? Fed’s latest transparency sows confusion, says Mizuho’s Ricchiuto

The complexity of non-traditional monetary policy is hard enough to explain to other economists and policymakers. Market participants prefer sound bites, opines Steven Ricchiuto, chief economist at Mizuho Securities USA in a note. As such, the more the Federal Reserve Chairman Ben Bernanke tries to explain the Federal Open Market Committee’s position on tapering and policy accommodation the more he confuses the message, Ricchiuto says.

The problem is fundamental to the nature of monetary policy. According to the Chairman, monetary policy accommodation is adjusted through the Fed Funds rate. Quantitative Easing (QE) is a separate policy. Yet he has also said that tapering is simply reducing accommodation, not tightening. These pronouncements work at cross purposes and ignore how the markets read policy. For the markets, QE is an extension of policy into non-traditional tools. Therefore, tapering is tightening. There is no such thing as reducing accommodation for market participants.

For the FOMC, it is the stock of bonds that have been purchased that defines policy, Ricchiuto says. Essentially, if the Fed stops buying Treasury and mortgage-backed securities but the Fed’s System Open Market Account (SOMA) doesn’t sell any, then policy is unchanged. This implies that long-term rates should remain unchanged.

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.

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.”

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.