Despite popular belief, we take no comfort in the decline in interest rates and argue that it should be viewed as a bad sign.
So says Shyam Rajan of BoAML’s liquidity insight report team, and in so doing echoes the thoughts and sentiments of probably the entire banking industry.
We’ve noted before – channeling Paul Krugman, no less — that zero rates (even more so negative rates) are not a banker’s cup of tea. Indeed, with little capacity to pass negative rates onto customers, the lower for longer scenario compromises hallowed net interest margins, the key source of predictable and sustained revenue for banks. All other services from origination to advisory collect one-off based fees. As great and balance-sheet light as they may be, they’re variable and thus unpredictable, hence inconsistent with the historical reason for buying bank stock. Read more
Raghuram Rajan, the luddite at the RBI (for now at least) has been banging on a particular drum for a while.
He told the world — at an IMF conference in Delhi earlier this year — that a system of rules governing the effects of monetary policy (or behaviour, if you will) would be nice. It would be based primarily on spillovers and ranked according to a Green, Orange, Red system familiar to anyone who has ever had a work-review of anything, ever. Green equals good, for those who have understandably repressed previous encounters with this type of system.
In a subsequent paper Rajan put more meat on the bones of his idea and now here it is in handy table form laying out those suggested rules for the monetary game, courtesy of Prachi Mishra, also of the RBI and Rajan’s occasional co-author: Read more
A quick reminder that we’ll be hosting a special edition of Macro Live today at 1:50pm to cover the release of the FOMC statement and subsequent presser.
Back in December 2015, Federal Reserve policymakers expected they would raise the policy interest rate band to 1.25-1.5 per cent by the end of 2016, implying a cumulative increase in short-term rates of 1 percentage point, or four separate decisions to raise rates by 25 basis points. At the time, the prices of overnight index swaps implied an 11 per cent chance this would happen, according to Bloomberg’s WIRP function. Read more
This guest post from Manmohan Singh warns that while QE created excess reserves, removing those reserves from the system will have an important impact on the markets’ financial plumbing – and that will need to be incorporated in monetary policy decision making. Singh is the author of Collateral and Financial Plumbing and a senior economist at the IMF. Views expressed are his own and not of the IMF.
Expanded central bank balance sheets that silo sizeable holdings of US Treasuries, UK Gilts, Japanese Government Bonds (JGBs), German Bunds and other AAA eurozone collateral have placed central bankers in the midst of market plumbing. It’s now going to be very difficult for them to walk away from that role. Read more
This post is from Gerard MacDonell, an economist at Point72 Asset Management, formerly SAC, from 2004 through 2015…
With the risk of recession and a return to the zero bound now prominent, there is renewed discussion of the Fed and Treasury coordinating to deliver a helicopter drop of money.
This would not work in the US because the inflationary implications of it would be too dire and because the Fed would predictably renege on its side of the bargain. Here’s why, as I see it. Read more
A quick reminder that we’ll be hosting a special edition of Macro Live today at 1:55pm to cover the release of the FOMC statement and subsequent presser.
There’s only a 3.4 per cent chance the Federal Reserve will raise rates today, according to Bloomberg’s WIRP function and the prices of overnight index swaps.
As recently as the end of December 2015, market prices implied odds of at least one rate hike by tomorrow at more than 40 per cent:
We want to highlight a speech from the Bank of Canada’s Timothy Lane on Monday. Whilst the conclusions are not particularly new, Lane makes several points that can’t be repeated enough.
Start with his description of how changes in monetary policy affect the economy: Read more
Stocks and corporate bonds haven’t been doing so well lately, while the market-implied probability of four Fed rate hikes by the end of this year — the median expectation of policymakers as of December — has plunged below 1 per cent (according to Bloomberg’s WIRP function, anyway). Reasonable people are now starting to wonder whether another downturn is imminent.
Changes in prices could be signalling weakness yet to be captured by the official statistics on employment, output, and incomes. Even if you don’t believe asset prices contain useful information, it’s possible the hit to net wealth could encourage households and businesses to cut spending, thereby leading to recession and job losses.
We can’t answer whether a recession is around the corner, although the probability of another downturn necessarily rises with time since the last one. Instead, we want to lay out some of the main arguments and think through what various downside scenarios might look like. Read more
History never repeats and most analogies are wrong, but there are some intriguing parallels between the global macro environment in 1997-8 and today.
Back then, the Federal Reserve controversially chose to ease policy, first by refraining from rate hikes anticipated by the markets and then by cutting its target for Fed funds by 75 basis points. Many believe this choice inflated equity prices and encouraged excessive business investment at a time when America’s economy was already running hot. Despite the subsequent fillips of tax cuts, a boom in defence spending, and a housing bubble, the aftermath was a massive decline in employment and painfully slow recovery.
A simple comparison between conditions then and now suggests the Fed’s explicit desire to “normalise” financial conditions may come from a desire to avoid repeating the experiences of the late 1990s. Whether policymakers are right to prioritise the real economic data, which tells us what’s already happened, over the action in the financial markets, which tends to affect what will happen, is anyone’s guess. Read more
In this guest post, Erik Weisman, the chief economist of MFS Investment Management, explains why past Fed hiking cycles aren’t a good guide for predicting what will happen this time.
As the Federal Reserve prepares to raise interest rates, perhaps as early as the December meeting, many investors are looking at past rate hiking cycles for clues about how markets will react this time. Often we turn to the familiarity and convenience of what we’ve seen in the past to try to predict the future.
But that can make us look in the wrong place – and Fed tightening cycles over the last 30 or so years are simply not a good guidepost for what lies ahead. Read more
Once upon a time people thought central banks could boost business investment by lowering interest rates.
Thus America had its Large-Scale Asset Purchase programmes, which, according to the Fed, lowered longer-term Treasury yields. Again, according to the Fed, part of the appeal of these purchases was the impact they would have on investors with fixed income liabilities. Unable to hit their return targets with safer bonds they would be forced to buy riskier instruments, which, in theory, should improve the flow of credit to businesses and households and therefore spending. Read more
After a considerable period of boredom, trying to figure out America’s central bank has gotten interesting again.
For months, the mid-September meeting of the Federal Open Market Committee was being telegraphed as the most likely start date of the “normalisation” process. Or, to use another bit of central banker-ese, the day when short-term interest rates would begin “liftoff” from the current range of zero to 25 basis points. Read more
If Jeremy Corbyn becomes leader of the UK Labour Party, one positive consequence will be the ensuing discussion of the monetary policy transmission mechanism.
It all started with his presentation on “The Economy in 2020” given on July 22:
The ‘rebalancing’ I have talked about here today means rebalancing away from finance towards the high-growth, sustainable sectors of the future. How do we do this? One option would be for the Bank of England to be given a new mandate to upgrade our economy to invest in new large scale housing, energy, transport and digital projects: Quantitative easing for people instead of banks. Richard Murphy has been one of many economists making that case.
That passage seems to have been mostly ignored until August 3, when Chris Leslie, Labour’s shadow chancellor, attacked the policy, which in turn led to a detailed response from the aforementioned Richard Murphy (see also here and here), at which point what seems like the bulk of the British economics commentariat erupted. Just search the internet for “Corbynomics” if you don’t believe us. Read more
Even if it could identify bubbles, monetary policy is far too blunt a tool for effective use against them.
–Ben Bernanke, October 15, 2002
Policy accommodation—and the expectation that it will persist—is distorting asset prices. Most of this distortion is deliberate and a desirable effect of the stance of policy. We have attempted to lower interest rates below long-term equilibrium rates and to boost asset prices in order to stimulate demand.
–Donald Kohn, March 16, 2004
Kohn’s belief that monetary policy can reinvigorate a weak economy by encouraging people to borrow and spend out of unrealised capital gains is hard to square with Bernanke’s claim that central bankers shouldn’t attempt to restrain excessive risk-taking by raising interest rates. Bernanke reconciles this apparent asymmetry by arguing that “targeted measures…such as financial regulation and supervision” can promote financial stability better than the “blunt” instrument of monetary policy. Read more
Ask most monetary policymakers how they think about their job and the conversation generally goes like this:
- There is “an equilibrium interest rate” that somehow balances out the desires of savers and borrowers
- This “equilibrium rate” can be estimated roughly in real time
- The role of the central bank is to ensure that actual interest rates align with this theoretical ideal
We don’t really buy any of these points, especially 2) — see our earlier post discussing research by BAML’s Ethan Harris and Goldman’s Jan Hatzius, among others, on the difficulty of determining the “equilibrium” rate at any point in time — so naturally we want to highlight some new papers that reinforce our monetary policy nihilism. Read more
When it comes to central banking, we tend towards nihilism: the economy is far too complex for any policy rule, but also too complex to be understood by even the most intelligent, well-meaning technocrats. That presents an insurmountable problem for monetary policymakers, who are forever doomed to be fumbling about in the dark rather than smoothing out the vicissitudes of the cycle.
So we were intrigued to read a new paper by, among others, Goldman’s Jan Hatzius and BAML’s Ethan Harris, which was presented on Friday at the Chicago Booth Monetary Policy Forum, that basically agrees with our view. Read more
Eric Rosengren, the President of the Federal Reserve Bank of Boston, gave a speech in Frankfurt on Thursday arguing that the Fed’s full employment mandate gave the central bank more flexibility to be aggressive earlier, and that open-ended programmes that are tied to economic targets are more effective than purchases of predetermined size and duration.
Nothing novel there. But his speech also contained, perhaps inadvertently, some interesting arguments that the rounds of bond-buying after the acute phase of the financial crisis did little for the real economy. (We covered the tenuous relationship between asset purchase programmes and inflation here.) Read more
Housing booms are wasteful — and the subsequent busts are deeply destructive. Worse, they have become bigger and more frequent since the 1970s. An important new paper from Oscar Jorda, Moritz Schularick, and Alan Taylor places the blame on structural changes in the financial sector that exacerbate the impact of excessively loose monetary policy.
This is a continuation of earlier research on the drivers of credit booms and their impact on GDP using data from more than a dozen rich countries going back to 1870, which we covered in detail here. For those who don’t want to reread that post, the two important takeaways are, first, that the growth rate in private borrowing during an economic expansion predicts the severity of the subsequent downturn even when there is no financial crisis: Read more
Whilst strolling on a beach in southern California over the holidays, we were inspired to try our hand at songwriting. (The topic may or may not have been partly inspired by our location.) After toying around with our initial idea for a while we managed to produce a few verses and a refrain. Feel free to suggest additional lyrics in the comments. To the tune of Jingle Bells:
Rolling down the curve
With my Eurodollar strips
Making tons of money
‘til the Fed hikes 50 bps! Read more
**10.5 per cent to 17 per cent**
Click to enlarge for the Central Bank of Russia’s emergency rate hike at 1am Moscow time — surpassing both the Turkish central bank’s hike in January this year and the Bank of England’s 500bps of moves on one day in 1992. Lamontsky.* Read more
CreditSights points out today that changes in gross ECB liquidity provided to the euro area’s banking sector closely track changes in 10 year Bund yields:
A fascinating chart from Morgan Stanley’s European banking research team caught our eye. See if you can spot the odd one out (click to enlarge):
Back in 2011, inflation climbed above the Fed’s 2 per cent target, but the FOMC resisted the impulse to tighten monetary conditions. Long-run inflation expectations hadn’t risen to worrying levels, and Ben Bernanke perceived that a price spike led by oil was likely to be “transitory”.
No surprise there: he wrote the paper on this very topic. And he was proved right. Read more
The Bank of England’s latest quarterly bulletin, released on Monday, contains an interesting article on “the potential impact of higher interest rates on the household sector.”
A few interesting tidbits:
–Raising rates by 2 percentage points would redistribute income “from higher-income to lower-income households”
–But would probably lead to a reduction in spending, since 60 per cent of borrowers would spend less and only 10 per cent of savers would spend more. The BoE estimates that the net effect of a 1 percentage point increase in the Bank Rate would be a reduction “aggregate spending by around 0.5 per cent via a redistribution of income from borrowers to savers.” A 2 percentage point increase would lower spending by 1 per cent. (The total impact on spending could be a bit different, however, since monetary policy works in other ways besides redistributing income from net savers to net borrowers.)
–On the whole, though, UK households are (slightly) less sensitive to increases in interest rates than they were a few years ago Read more
Back in April, Paul Krugman wrote that Swedish post-crisis central banking has been “sadomonetarism in action.” (They had the audacity to modestly raise short-term interest rates in 2010-2011.) The criticism may lead to additional parliamentary oversight of the Riksbank.
So we recommend you read an important new speech from deputy governor Per Jansson that dispels many of the myths surrounding Swedish monetary policy. He makes two basic arguments: Read more
Policy should not respond to changes in asset prices, except insofar as they signal changes in expected inflation.
–Monetary Policy and Asset Price Volatility, by Ben Bernanke and Mark Gertler (1999)
That thesis became conventional wisdom in the years leading up to the recent financial crisis. Central bankers came to think it would be presumptuous for them to act as if they knew more than the collective wisdom of the markets. Even if they could spot trouble in advance, the consensus was that there was no way to temper excesses in the financial system without tanking the economy in the process. Better to stick to the (seemingly) simpler task of inflation targeting. Read more
Nonsense is a rude word. But there isn’t a milder way of describing the Bank of England’s estimates of UK labour market slack.
For three inflation reports in a row, the BoE has published a chart (below) showing its model of labour market slack with accompanying text highlighting its great importance in the monetary policy decision. “One of the key determinants of inflationary pressures in the economy is spare capacity or slack – that is the balance between demand and supply,” the November inflation report states. Read more
Sweden’s Riksbank cut its key interest rate to zero last week because inflation was too low. The Riksbank has been noted – and criticised – for raising rates in 2011 to tackle a credit and housing bubble. Peter Doyle, an economist and former mission chief for Sweden for the IMF, argues that the recent experience of the world’s oldest central bank has more to teach policymakers.
One view of the Swedish Riksbank’s cutting its repo rate to zero is that this is a defeat for the use of monetary instruments to lean against financial fragilities. That conclusion is premature. It misses three more important implications for other monetary policymakers. Read more
(The chart frames the upper and lower forecasts of the central tendency, which removes the highest three and lowest three forecasts of the FOMC as a whole. The red line is the midpoint between the two.)
Starting in 2009, the midpoint of the central tendency projections for the long-run unemployment rate climbed from 4.9 per cent to 5.6 per cent during the next three years. Read more