MacroScope

Another U.S. debt ceiling showdown could roil markets: NY Fed paper

After two days of testimony from Federal Reserve Chairman last week in which he decisively criticized Congress’ decision to slash spending arbitrarily in the middle of a fragile economic recovery, a report on money market funds from the New York Fed nails home the point.

The paper’s key finding is that, as most observers already knew, investors were a lot more worried about a break-up of the euro zone in the summer of 2011 than they were about U.S. congressional bickering over the debt ceiling.

But as Americans face a series of regularly schedule mini-eruptions in the fiscal policy arena, the authors conclude with a thinly-veiled warning to lawmakers:

The relatively benign effects of the 2011 U.S. debt-ceiling crisis on U.S. financial markets appear to have been serendipitous, as the U.S.and European debt crises occurred concurrently. Money funds nevertheless reacted to the increased riskiness of Treasuries by dramatically decreasing the maturities of Treasuries held in their portfolios during the debt-ceiling crisis. This behavior suggests that we can’t be sure that the effects of future fiscal crises on financial markets will be similarly benign.

Bernanke: The quickest way to raise rates is to keep them low

That’s not a typo in the headline. In a recent speech that took some mental gymnastics to absorb, Federal Reserve Chairman Bernanke countered critics of his low rates policy by arguing that a loose monetary policy is the best way to ensure rates can rise to more normal levels.

Why? Because interest rates will naturally move higher once stronger economic growth leads to higher rates of return on investment, Bernanke said. Here’s his argument:

One might argue that the right response to these risks is to tighten monetary policy, raising long-term interest rates with the aim of forestalling any undesirable buildup of risk. I hope my discussion this evening has convinced you that, at least in economic circumstances of the sort that prevail today, such an approach could be quite costly and might well be counterproductive from the standpoint of promoting financial stability. Long-term interest rates in the major industrial countries are low for good reason: Inflation is low and stable and, given expectations of weak growth, expected real short rates are low. Premature rate increases would carry a high risk of short-circuiting the recovery, possibly leading–ironically enough–to an even longer period of low long-term rates. Only a strong economy can deliver persistently high real returns to savers and investors, and the economies of the major industrial countries are still in the recovery phase.

The real sequester threat: rising political risk in the United States

Despite the Obama administration’s cataclysmic warnings about the effects of $85 billion in looming spending cuts known as the “sequester,” chances are the lights will not go out when they kick in this weekend. Still, the economic impact could be significant. The cutbacks might shave a half percentage point or more from an economy that is forecast to grow around 2 percent this year — but which only mustered a 0.1 percent increase in annualized fourth quarter GDP. This, at a time when a similar austerity-driven approach has left much of Europe mired in recession.

Both the public and the markets seem to be taking Washington’s latest war of words in stride. After all, people are becoming inured to the regularly scheduled fiscal crises that have become a part of the capital’s landscape. But the sequester’s most frightening potential consequence is much broader than its near-term economic ripples. The real danger is that, with every new episode of political theater over the budget, America’s credibility as a serious, trustworthy nation is eroded. The concept of political risk, once reserved for banana republics in the developing world, is now very much alive in the United States. And that is one liberty a debtor nation cannot afford to take.

Hey brother, can you spare a coupon?

Remember those green shoots? Ever since Fed Chairman Ben Bernanke uttered those words in response to the first signs of recovery from the Great Recession in 2009, many forecasters – including Fed officials – have consistently overestimated the economy’s strength.

Some economists believe 2013 could finally be a break-out year. With the fiscal cliff now in the rear-view mirror and the euro zone crisis apparently stabilized, some see the prospect that growth could actually exceed expectations for the first time in a long while.

Dennis Lockhart, president of the Atlanta Fed, said this week he sees a chance the economy might actually surpass his 2013 growth forecast range of 2-2.5 percent.

Bernanke’s Senate tone not that of Fed Chairman seeking third term

Federal Reserve Chairman Ben Bernanke may be keeping quiet about his future plans, but he sure doesn’t sound like someone planning to seek Senate support for a third term at the helm of the U.S. central bank.

In unapologetic and sometimes testy exchanges before the Senate Banking Committee on Tuesday, the Fed chief defended his record and dismissed one Senate critic in unusually blunt terms.

“None of the things you said are accurate,” Bernanke told Bob Corker, a Republican senator from Tennessee, who accused the Fed of deliberately starting a global currency war and of printing money to bail out big Wall Street banks.

As U.S. debates immigration, Fed’s Fisher tells his dad’s story

When Dallas Federal Reserve Bank President Richard Fisher and inveterate QE3 critic spoke Thursday evening at a black tie insurance industry event in booming Dallas, he left monetary policy out completely. As he often does with a speech directed at fellow Texans, he bragged on the Lone Star State, its job-generating prowess and its resilience since the Great Recession.

And then, in a tale he rarely tells publicly but that has particular resonance amid the rancorous national debate on immigration, he talked of another spectacular success: his dad. “This man is why, despite the current slow economic recovery we are experiencing outside of Texas, despite the fiscal tomfoolery of our national politicians, both Democrats and Republicans, despite the negativism and bad news that pervades the headlines, I have great faith in this country,” he said.

At age five, Fisher’s father was convicted of being a “neglected child” in Queensland, Australia, having been found sleeping under bridges and in doorways with his drunken father. He was sent to a reformatory, then to an orphanage, then to a series of foster families, one of which tied him up in the yard at night by the ankle and woke him “ in the predawn hours to deliver milk by horse drawn carriage.” His teeth rotted. He went to South Africa, drove buses, married, and sailed to the United States, “only to discover that his record and lack of documentation made him inadmissible.”

Fed stimulus benefits still outweigh risks, Lockhart tells Reuters

The Federal Reserve is cognizant of the potential costs of its unconventional policies, but the economic benefits from asset purchases are still far greater than the potential costs, Atlanta Fed President Dennis Lockhart told Reuters in an interview from his offices.

What follows is an edited transcript of the interview.

The December meeting minutes seemed to signal a shift in sentiment at the central bank toward a greater focus on the policy’s costs. How concerned are you about the risks from QE? Has the cost/benefit tradeoff changed for you? What’s your sense of how long you’ll need to keep going?

I would not say at this point that, in any respect, the costs, which are largely longer-term and speculative, outweigh the benefits of maintaining a highly accommodative climate that is being contributed to by both large-scale asset purchases and our interest rate policy. Having said that, I think policymakers have to be aware that in a policy such as quantitative easing or large-scale asset purchases, continuing to build up the challenge of reversal of that policy, or the challenge of normalization, has to be on your mind. I don’t think we’ve gotten to the point where the costs outweigh the benefits. I’m a believer, although of course it’s very hard to isolate cause and effect in the real world, that our policy has benefited the economy and that the improving situation that we are now seeing is at least in part a result of monetary policy.

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.

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.

A statement of non-intent

The flurry of activity about a G7 currency statement yesterday can now be put in perspective. It will almost certainly happen but it’s very much going through the motions.

We’ve been saying for a while that having urged it to reflate its economy for some time, Japan’s partners could hardly complain now that it is. Lael Brainard of the U.S. Treasury basically let that cat out of the bag last night, warning against competitive devaluations but saying that Washington supported Tokyo’s efforts to reinvigorate growth and end deflation.

What we’ll get is a bland recommitment to market-determined exchange rates and not much more.