MacroScope

At the Fed, there’s a way to raise rates — but is there a will?

The Federal Reserve has kept its key federal funds rate at near-zero for four straight years, and it expects to keep it there for at least two more. But with each trip around the sun, outsiders wonder whether central bank policymakers will act without hesitation when the time finally comes to tighten monetary policy?

This week, the official with his hand on the Fed’s interest-rate lever, so to speak, asked that same question. Simon Potter, head of the Federal Reserve Bank of New York’s open market operations, was at NYU‘s Stern School of Business discussing the various ways the central bank can tighten policy: the federal funds rate; the interest rate on excess bank reserves; reverse repurchase agreements. Potter runs the unit that carries out Fed policy in the market, and sits in on most policy-setting meetings in Washington. Asked by a student about the inflationary or deflationary risks associated with tightening policy in the future, he had this to say:

The real heart of that question is a willingness one. I’m pretty confident we have the technical ability to raise rates. The hard part will be the willingness in some people’s minds. What I’ve seen among most people in financial markets is they’re pretty sure that the Fed will raise rates when it’s appropriate to do it… Definitely compared to 2009-2010, the type of hedge funds and people who took large bets thinking this would lead to high inflation have given up on that bet.

Could the private sector stage a stimulus plan?

Since the financial crisis, the federal government has implemented a fiscal stimulus plan and the Federal Reserve took to the road of monetary stimulus, actively seeking new routes to revive the U.S. economy.

The private sector, however, has been laggard in adding its muscle to the revival efforts. Private firms have added employees, but very cautiously, and wages are stagnant. Meanwhile, a huge amount of cash sits idle on corporate balance sheets.

“Capital expenditure plans are being retrenched,” notes Dan Heckman, senior fixed income strategist and senior portfolio manager at Minneapolis, Minnesota-based US Bank, with $80 billion in assets under management. “Most major corporations are sitting on tons of cash. They have no appetite for borrowing and credit line utilization is at all-time lows.”

The trouble with the Fed’s calendar guidance on rates

Sometimes, communication can be the art of what not to say. Federal Reserve Chairman Ben Bernanke took pains this week to make clear that the central bank’s indication that it will likely keep rates low until mid-2015 does not mean it expects growth to remain weak for that long.

By pushing the expected period of low rates further into the future, we are not saying that we expect the economy to remain weak until mid-2015; rather, we expect – as we indicated in our September statement – that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.

The comments speak to a key problem with the notion of calendar-based forward guidance, first adopted by the Fed in August of 2011: each time officials push the date further into the future, they risk dampening financial market sentiment, thereby having the opposite effect to the stimulus it intended.

NY Fed’s Dudley: “Blunter approach may yet prove necessary” for too-big-to-fail banks

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It was kind of a big deal coming from the Federal Reserve Bank of New York’s influential president William Dudley. The former Goldman Sachs partner and chief economist has offered a fig leaf to those who say the problem of banks considered too-big-to-fail must be dealt with more aggressively. Some regional Fed presidents have advocated breaking up these institutions. But Dudley and other powerful figures at the central bank have maintained recent financial reforms have already laid the groundwork for resolving the issue.

At a gathering of financial executives in New York last week, Dudley said he prefers the existing approach of making it costlier for firms to become big in the first place. Still, he left open the possibility of tackling the mega-bank problem more directly:

Should society tolerate a financial system in which certain financial institutions are deemed to be too big to fail? And, if not, then what should we do about it?

How big will the Fed’s QE3 end up being?

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Polling data courtesy of Chris Reese

We’ll know it when we see it. That’s essentially been the Federal Reserve’s message since it launched an open-ended bond-buying stimulus plan that it says will remain in place for as long “the outlook for the labor market does not improve substantially.” Which begs the question: how much larger is the central bank’s $2.9 trillion balance sheet likely to get?

Minutes from the Federal Reserve’s October meeting point to solid support within the central bank for ongoing monetary easing via asset purchases well into 2013.

A number of participants indicated that additional asset purchases would likely be appropriate next year after the conclusion of the maturity extension program in order to achieve a substantial improvement in the labor market.

Fiscal cliff could help U.S. avoid road to Japan – but probably won’t

The “fiscal cliff” is widely seen as a massive threat looming over a fragile U.S. recovery. But with a little imagination, it is not difficult to see how the combination of expiring tax cuts and spending reductions actually presents an opportunity for tilting the budget backdrop in a pro-growth direction, even if political paralysis makes this scenario rather unlikely.

For Steve Blitz, chief economist at ITG in New York, the cliff presents a unique chance for the United States to avoid sinking deeper in the direction of Japan’s growth-challenged economy by shifting incentives away from consumption and towards investment:

If current negotiations end up simply turning the “cliff” into a 10-year slide an opportunity to help the economy regain a dynamic growth path and close the gap with pre-recession trend GDP would, in our view, be lost and raise the odds that, in the coming years, U.S. economic performance looks more like Japan’s. […]

Roaring auto sector could charge up U.S. growth

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Economists love motor analogies, and for good reason: they are very useful in illustrating the ebb and flow of economies. In coming months, maybe even years, the help from the auto sector could become a lot more literal, argues Paul Dales, senior U.S. economist at Capital Economics in London. In particular, he expects rising sales following years of depressed consumer spending on vehicles in the wake of the Great Recession could add as much as 0.25 percentage point to U.S. gross domestic product growth per year over the next four years. Here’s why:

The rise in new vehicles sales in September, to 14.9 million from 14.5 million in August, was significant as the number of new vehicles being purchased is now higher than the number being scrapped. This comes after four years in which the total number of vehicles in operation has been declining.

That fall was because when the recession hit and credit seized up, both households and businesses had little choice but to run their existing vehicles for longer. It is possible that 10 million fewer new vehicles have been sold than would have been the case if there was no recession.

Fed’s Lockhart explains what he means by “substantial improvement” on jobs

Federal Reserve officials have linked their open-ended stimulus program to substantial improvement in the labor market. So now, it’s up to Fed watchers to hone in on a definition of substantial, no small task in a world of multiple and often conflicting indicators on the job market.

In a speech to the Chattanooga Rotary Club on Thursday, Dennis Lockhart offered some insights into how he’s thinking about the process:

For policy purposes, I think it’s appropriate to be cautious about relying on a single indicator of labor market trends—for example, the unemployment rate—to determine whether the condition of “substantial improvement” has been met. The official national unemployment rate published by the Bureau of Labor Statistics is the most prominent statistic in the mind of the general public. As a policymaker, I want to have confidence that a decline of this headline number is reinforced by other indicators and evidence of broad labor market improvement in its many dimensions. The challenge my FOMC colleagues and I will face is communicating in simple and trackable terms what this phrase “substantial improvement” means while respecting the complex reality of many moving parts. […]

Unsaving the U.S. economy

The U.S. savings rate sank last month to its lowest since November, official data showed this week, in a sour reminder of how the economy is still dangerously exposed to any financial downturn or other shocks like the fiscal cliff. Following are some facts about this usually overlooked indicator:

* The U.S. saving rate is basically the amount of dollars Americans are able to save from their wages after spending and paying taxes, as a percentage of income. In September the rate was at 3.3 percent, a drop from 3.7 percent the previous month and the lowest since 3.2 percent in November 2011.

* The 3.3 percent rate is much worse than the healthy 8.1 percent average of the 1950s and 60s, the Golden Age of the U.S. post-war economy. It is also below the 5.5 percent average of the 1990s.

Economists revise down third quarter U.S. GDP forecasts as business investment missing in action

Richard Leong contributed to this post

U.S.durable goods orders rebounded a solid 9.9 percent in September following the prior month’s plunge. However, a proxy for business investment was essentially stuck in neutral. This was sufficiently worrying to JP Morgan economists to force them to revise down their estimates for third quarter U.S. economic growth down to 1.6 percent from 1.8 percent. Barclays economists also marked down their Q3 GDP forecast by 0.2 percentage point, putting it at 1.8 percent. The Reuters consensus forecast for the number, due out on Friday, is 1.9 percent.

JP Morgan economist Mike Feroli:

Don’t let the headline fool you: the September durables report was a big disappointment. In particular, the weakness in the capital goods figures leaves intact our concerns regarding the capex outlook. In light of today’s report we are revising down our expectations for tomorrow’s 3Q GDP report from 1.8% to 1.6%. We continue to look for 2.0% growth in 4Q, though there is now some downside risk to our business investment projection for next quarter. […]

Core capital goods orders were flat last month and core capital goods shipments were down 0.3%. These figures may not look so bad until you consider two factors; first, both numbers had been weak over the prior few months and some rebound was expected, and second, both numbers tend to be strong in the third month of the quarter. Topping it all off, both numbers were revised down a decent amount in August. All of these factors get reflected in the three-month average annualized change, which shows shipments declining at a 4.9% pace and orders sinking at a 23.5% annual rate.