MacroScope

Federal Reserve Chairman Ben Bernanke has made clear the central bank is considering another round of monetary stimulus. Fed officials have also suggested that if they were to embark on a third round of quantitative easing via bond purchases, or QE3, they could favor mortgage-backed securities in an effort to boost housing.

Not to read too much into anecdotal evidence, but it’s hard not to see some symbolism in Bernanke’s next public appearance, announced late on Thursday. On February 10, Bernanke will be in Orange County, California, one of the epicenters of the U.S. housing crisis. His chosen forum? The National Association of Homebuilders International Builders’ Show. The topic: Housing Markets in Transition.

Federal Reserve Chairman Ben Bernanke’s verdict on the U.S. economy is sobering. Boiled down, this was the message delivered at his news conference today:

Brace for roughly three more years of sluggish growth – or longer Some of the unemployed will not find work in the foreseeable future America’s economic power has downshifted Global financial markets could upend recovery yet again

It is a bleak outlook. Bernanke has left little doubt that he sees the United States in the midst of very long and painful period of sub-par growth, dousing some of the optimism stirred by recent reports that showed unemployment falling, the housing market hitting bottom and businesses starting to spend again.

Conditions could worsen, especially if the European crisis deepens and tips the world back into recession as the IMF warned this week. Bernanke said the central bank is ready to pump even more cash into the economy to keep it afloat if necessary. And by formally announcing for the first time that the central bank has inflation target of keeping prices at 2 percent, Bernanke has bought himself the leeway to provide extra support to growth without stoking inflationary fears.

Forecasting hard data can be difficult enough. Estimating the forecasts of individual Federal Reserve policymakers is even tougher. But, in advance of the Fed’s latest effort at policy transparency, that’s just what Goldman Sachs economists have attempted to do.

The Fed announced last week it would begin publishing policymakers’ own forecasts for the path of interest rates, in addition to the growth, inflation and employment projections they already release on a quarterly basis. Goldman uses the Taylor rule of monetary policy, which governs the relationship between economic slack and inflation, to estimate when individual policymakers would likely perceive the timing of an eventual interest rate hike.

The findings are interesting, particularly because they find that, contrary to the view chronicled in this post, the publication of Fed officials’ forecasts might actually have the effect of tightening financial market conditions.

The Fed’s decision to begin publishing policymakers’ own forecasts for the path of policy may effectively constitute a minor easing of the central bank’s already ultra-loose monetary policy at its Jan. 24-25 meeting, according to Harm Bandholz of UniCredit. That’s because in doing so, officials will likely show that they expect the benchmark federal funds rate to remain near rock bottom levels until later than mid-2013 – the Fed’s current guidance on policy.

While the minutes do not say in which direction the forward guidance should be adjusted, we assume that mid-2013 is seen by many FOMC officials as too early. In that context, the decision for Fed officials to publish their projections of the target fed funds rate could provide an opportunity for a back door policy easing in January. If e.g. most participants would not pencil in any rate hike until the end of 2014, the market would certainly take this as a strong signal.

Along the same lines, David Hensley at JP Morgan says:

All else constant, these projections would further flatten the yield curve if the FOMC signals a later start to rate hikes than currently is discounted in markets.

Economic forecasters, including those at the Federal Reserve, have notoriously poor aim. Last month, the central bank revised sharply lower its projections for U.S. gross domestic product in 2012 – just as U.S. data began to turn in a more positive direction.

But at least one Fed call appears to be on the mark: overall inflation is coming down as energy prices ease on the expectation of slowing global demand. This, in turn, may soon lead to a curious phenomenon. The core measure of costs, which excludes energy and food prices and tends to be lower than consumer prices as a whole, may soon exceed so-called “headline” inflation.

Eric Green at TD Securities, writes in a research note:

The November CPI data was benign and captures a trend over the next six months that will become more obvious – headline is poised to decelerate through core prices. Core inflation will prove more sticky to the upside rising toward 2.3% y/y over coming months while headline prices fall toward 1% y/y by May. That will encourage a perceptible bias lower in breakevens (one that could accelerate if Europe goes Kaboom in Q1), and it provides the Fed more leeway to become more proactive should growth decelerate over H1 as we suspect it will.

The Federal Reserve, which on Wednesday sharply downgraded its outlook for U.S. economic growth and employment, appears to be seriously considering another round of monetary easing. In what would represent a policy U-turn, any third round of quantitative easing or QE3 appears increasingly likely to be heavily tilted toward purchases of mortgage-backed securities.

The idea was recently floated rather surprisingly by Fed Governor Daniel Tarullo, who normally focuses on regulatory issues. Some analysts had speculated Tarullo might not have broad support, but Fed Chairman Ben Bernanke’s comments on the matter during his post-meeting press conference on Wednesday suggested otherwise:

The housing sector is a very important sector. Problems in that sector are a big reason why our economy’s not recovering more quickly. I do think that purchases of mortgage-backed securities is a viable option. Certainly, something we would consider if the condition were appropriate. So the answer is yes, we will certainly look into that.

As the Fed ponders providing another round of stimulus to a weak U.S. economy, it is difficult to keep track of the views of individual central bank officials. This newly-updated hawks-doves chart should help cut through the clutter. One good rule of thumb: keep a close eye on Ben Bernanke. The Fed Chairman is highly respected by his colleagues and his views usually carry the day.

*Update: here’s another interactive graphic focused on just the 10 current voting members on the Fed’s policy-setting panel.

As policymakers debate how to bring down an unemployment rate stubbornly stuck above 9 percent, Chicago Federal Reserve Bank President Charles Evans and Boston Fed President Eric Rosengren are embracing what might be called “the seven-percent solution.”

It works like this: the Fed pledges to keep rates near zero for as long as it takes to get some real improvement in the labor market – an unemployment  rate, say, of 7 percent – as long as inflation doesn’t get out of hand. That way, every time some good economic news comes out, markets don’t immediately start pricing in a rate hike, undoing the very easy policy that the Fed sees as necessary to pull the moribund jobs market from its deep hole. Don’t you worry about a little bit of inflation here or there, the Fed could say –  it’s steady as she goes until unemployment dips below 7 percent.

What, though, is so special about 7 percent? Certainly, it’s much better than the current 9.1 percent. But it still would leave millions unemployed, and Evans himself has said he believes that unemployment normally runs at less than 6 percent. Why settle for a bigger number?

The Federal Reserve’s long-quiet doves are becoming increasingly louder about championing more aggressive forms of monetary easing, including possibly setting employment and inflation targets and/or engaging in another round of bond purchases. Most prominent among these have been Charles Evans, the Chicago Fed president who openly favors more transparent policy guidance and Eric Rosengren, who told CNBC on Wednesday a third round of monetary easing could be in store:

If the economy were to be weaker than most people are forecasting, that would certainly be cause for doing additional monetary policy.

Rosengren also said he favors more explicit policy targets, which could take a rather controversial form known as price-level targeting. Under this arrangement, the Fed would temporarily shoot for higher inflation to make up for the almost deflationary readings seen late last year, in an effort to boost investment, spending and hiring.

Will they or won’t they (ease monetary policy further)? The question will again garner investors’ attention this week as Federal Reserve Chairman Ben Bernanke and a number of regional Fed bank presidents take to the podium. The speeches come against a backdrop of ongoing worries about economic growth, but on the heels of a number of releases that were not as bad as feared. The bar remains high for the Fed to actively engage in a third round of quantitative easing or QE3 — it would probably take renewed deflationary rumblings to get there.

For now, the Fed is likely to focus on less drastic steps, such as new ways of communicating its policy targets, to satiate wobbly financial markets’ apparent need for ongoing monetary support. Here is the line-up of speakers for this week:

Bernanke will deliver remarks on ”The Effects of the Great Recession on Central Bank Doctrine and Practice” at the Boston Fed on Tuesday at 1: 15 pm EDT.