It is probably the highest profile event on the Fed calendar: the chair’s opening speech at the Kansas City Fed’s symposium in Jackson Hole, Wyoming. The setting is spectacular; the audience runs the world’s central banks. Markets go on high alert for new guidance on policy. To add to the sense of occasion this year, it will be Janet Yellen’s first visit as Fed chair.
The oddity is that Jackson Hole’s reputation as a market mover is largely accidental. It is not an obvious venue for the Fed to communicate policy: what, in fact, could seem more out-of-touch than proclaiming the nation’s economic path from a gorgeous mountain resort in one of the richest zip codes in the USA? It is most likely, therefore, that Yellen’s speech on Labour Markets (the title has been announced) will contain a lot of important analysis but much less red meat on policy. Read more
The Federal Reserve has just released its first “Report on the Economic Well-Being of U.S. Households“. It provides some useful context for the ongoing debates about the income distribution and excess savings.
A few particularly dispiriting highlights: Read more
The White House has joined the debate about declining labour force participation with an excellent report from the Council of Economic Advisers. (The fingerprints of Harvard’s James Stock are in evidence in some punctilious time-series econometrics.)
The CEA reaches similar conclusions to a number of other studies. Most of the decline in labour force participation was demographic, due to an aging population; a modest proportion was due to the recession and its unusual severity. Read more
Note: FT Alphaville is now playing host to posts from the FT’s Money Supply box. Enjoy (and argue away, if you see fit). Here’s Robin Harding, the FT’s US economics editor…
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The Federal Reserve’s June minutes are out and as usual offer good insight into the FOMC’s thinking when it comes economic confidence and recovery (more positive) as well as its opinion on rates (still dovish).
But they also reveal a new preoccupation with matters related to exit strategy and financial plumbing.
Here’s the section we’re referring to (H/T David Beckworth)
While generally agreeing that an ON RRP facility could play an important role in the policy normalization process, participants discussed several potential unintended consequences of using such a facility and design features that could help to mitigate these consequences. Most participants expressed concerns that in times of financial stress, the facility’s counterparties could shift investments toward the facility and away from financial and nonfinancial corporations, possibly causing disruptions in funding that could magnify the stress.
Janet Yellen says share valuations remain within “historical norms”.
Two words: “irrational exuberance”. Read more
Should the Fed be unduly concerned by the decline in term premia this year?
Consider some the potential explanations given for the decline in yields: Read more
Last November, with the end of his tenure nearing, Ben Bernanke discussed an idea that Gavyn Davies refers to as The Separation Principle.
It begins with the simple concept that movements in long-term rates are explained by changes in two components: the term premium and the expected path of short rates. And while the Fed’s asset purchases mainly influence rates through their effects on the former, its forward guidance language works by altering the latter. Read more
Given the recent proliferation of debate about monetary policy and the fall in volatility — among central bank officials and the economics commentariat both — it might be worth revisiting first principles.
Start with the obvious point that the Fed’s monetary policy mandate says nothing about financial stability, which therefore must be a secondary variable. It matters only inasmuch as it affects the Fed’s ability to satisfy its mandates of price stability and full employment. This is mostly undisputed but not often stated plainly. Read more
A lot of people are puzzled over why US yields are falling when nothing has changed on the Fed communication side, and QE is supposed to be slowing.
Frances Coppola notes an even stranger phenomenon. When you look at the very big picture you realise that if there is a correlation between QE and rates, it’s actually a very counterintuitive one:
Every time QE is announced, yields rise: when it ends, they fall. And no, this doesn’t just affect the 10-year yield. The same basic shape can be observed on just about any maturity over 1 year (short-term rates are propped up by the positive IOER policy).
From Mohamed El-Erian’s latest offering to Project Syndicate:
Like Princess Anna in Frozen, it will take time for markets to recognize that their relationship with the Fed is changing (and should change); and, similar to the movie, some sort of shock may be involved in socializing the new understanding. Having said that, the outcome will certainly not be as dramatic as in the movie – if only because, unlike Hans, the Fed is not out to take over the markets. Read more
The Fed’s 2008 transcripts offer an impressive insight into the state of the repo markets in 2008, not least the shortage of safe US assets, which it turns out was a key area of concern in Fed gatherings.
We’ll have more on some of the other repo elements, but in the meantime — given that we’ve raised the idea that China might be inclined to repo its UST stock with the Fed if it needs short-term dollar liquidity (or is possibly doing so already) — it’s worth noting the following exchange from the October 2008 transcript in which the committee wondered about the nature of collateral they should accept for emergency dollar swap lines with foreign central banks.
Rather than collateralising with their own currency the idea was raised that they should pledge their UST stock instead. Voila, an open precedent for sovereign-level repo arrangements with the Fed so as to ease the shortage of safe asset problem in the West whilst at the same time flooding dollar liquidity to foreign markets. Read more
New era, and all that. Click the image to read Janet Yellen’s full prepared testimony for her appearance on Tuesday before the Committee on Financial Services, U.S. House of Representatives.
Here’s a rough sketch of the variables influencing US inflation, which has been remarkably low for two years running:
1) The remaining labour market slack, including a staggering and resilient long-term unemployment problem. The amount of slack remains tough to know given the difficulty of measuring the cyclical vs secular components of the fall in the labour force participation rate. Much more on this later.
2) The output gap. This isn’t a well-defined idea, we know, but few people would argue that the US economy is producing at potential. The US economic recovery does appear to have accelerated in the final two quarters of last year (the December jobs report notwithstanding), and the conditions for growth look better than they have in years. If the nascent acceleration proves sustainable, then the labour market may well tighten up and push wages higher. Obviously this is related to the first point about labour market slack, and plenty of caveats are needed given the head-fakes of the last four winters. Read more
Credit Suisse takes a look at the big December testing:
As expected, the end of the year brought the large-scale test of the Fed’s reverse repo facility, and the surrounding operations have dwarfed prior tests. In our view, the Fed needed to get some larger-scale tests under its belt to develop full confidence in the program’s capacity for both policy makers and the market. The year-end results seem to have delivered such a result. Read more
Justin Fox at the Harvard Business Review has collated some interesting extracts from a conversation he had with Alan Greenspan late last year.
What’s striking, as Fox himself notes, is that Greenspan (generally pigeon-holed as a free-market loving Ayn Randian type) is getting pretty Keynesian nowadays. Indeed, having understood that the 2008 crisis revealed a “flaw” in his world view, rather than getting bitter about it, Greenspan appears to have spent the last few years trying to understand where he went wrong.
A period of honest self-reflection has led to some major reversals in his thinking. Read more
At last December’s FOMC meeting, Ben Bernanke announced the new Evans Rule (forward guidance thresholds) framework at least one meeting before most observers had expected it.
This year, market participants and Fed reporters have differing predictions for what the same meeting will bring, but they aren’t ruling much out. Even if markets are probabilistically favouring certain policy moves over others, it’s unlikely that any announcement in particular will qualify as a surprise.
Here’s a summary of potential changes, each of which could be announced in isolation or in combination with others (and do note that “none of the below” is also very possible): Read more
The market vogue is to obsess about how the Fed is suppressing long-term rates.
But for years now, FT Alphaville has been trying to explain why, in reality, Fed intervention is as much focused on propping up short-term rates (preventing them from falling through zero) as it is about keeping longer-term rate expectations anchored. Read more
At some point in the great collective peyote dream that was last month’s debt ceiling crisis, we asked you to imagine the Fed buying defaulted US Treasuries.
Fortunately, the US central bank was thinking about it too. Read more
Click to read. No taper any time soon?
Some prominent Fed Reserve Board staffers recently put out two weighty papers in advance of the 4th Jacques Polak Annual Research Conference which is hosted by the IMF starting on Thursday (today).
Paul flicked one paper up yesterday — The Federal Reserve’s Framework for Monetary Policy –Recent Changes and New Questions — and the second — Aggregate Supply in the United States: Recent Developments and Implications for the Conduct of Monetary Policy — is here. Read more
The Federal Reserve’s Framework for Monetary Policy –Recent Changes and New Questions. Click to read the full doc.
Fresh from having made $1bn impeccably timing the putative US recovery in the first half of this year (and Japan, natch), Andrew Law of Caxton Associates – one of the world’s most successful macro traders – has now turned bearish, and in quite a big way.
Caxton, a hedge fund named after the printer (its now-retired founder Bruce Kovner is a billionaire bibliophile), believes the Fed will keep running its presses:
We have been expecting the US economy to reach escape velocity led by housing and corporate capital expenditure… but for whatever reason that just hasn’t happened…tapering is off the table for the foreseeable future.
Caxton is long across the US yield curve (the debt debacle has been a good buying opportunity, if nothing else). Mr Law has spoken extensively with us about his view on the global economy and the state of the hedge fund industry. Tree-based publishing issues mean those thoughts came in truncated form. Below are some extended excerpts from him. Read more
The FT’s Tracy Alloway and Michael Mackenzie report on Thursday that banks are making contingency plans to deal with the potential impact on the $5tn “repo market” of the US government missing a payment on its debt.
Which basically means determining when we should start treating a US Treasury Bill as a potentially defaulted security. Currently, you could say, the T-bill’s status exists in a quantum state. It could be the best collateral in the world, but then again it might not be. Which one it is depends entirely on an externality, and to some degree how we choose to observe it.
This is probably welcome news given that the role played by distressed collateral and repo markets back in 2008 is still poorly understood. Read more
Every Federal reserve bank shall have power…
…To buy and sell in the open market, under the direction and regulations of the Federal Open Market Committee, any obligation which is a direct obligation of, or fully guaranteed as to principal and interest by, any agency of the United States.
– Section 14.2(b)2, Federal Reserve Act
Now, reading that carefully…
Does that mean the Fed can’t buy defaulted US government debt? Read more
Ah, how we love the smell of US debt-ceiling drama in the morning.
In a note out on Monday, analysts at Bank of America Merrill Lynch give the chances of a US government shutdown this coming quarter a 30 per cent probability. They add that if it was to occur, it would probably be short-lived with minimal economic repercussions. Also, it’s not like a shutdown hasn’t happened before: it happened once in 1990, as well as once in 1995/1996. It wasn’t the end of the world then, and thus shouldn’t be the end of the world this time either. Read more
Click to enlarge the updated dove-hawk breakdown from Credit Suisse. Read more
You’ve seen those who were (ahem) surprised by the US central bank’s decision not to start tapering this month… now read the words of one who got it right: BNP Paribas’ Julia Coronado, the bank’s chief North America economist and ex-forecaster at the Fed.
And interestingly, BNP think even December is in doubt: Read more