US Interest Rates
The Fed sure seems to be getting comfortable with the idea of acting as a centralised counterparty for collateral transactions. It’s unclear whether the market’s quite as enamored with the idea. This year’s Jackson Hole conference was on monetary policy implementation, which often serves as a shorthand for the following questions: how should the Fed control interest rates, and how big of a role should it play in financial markets? While the topic seems arcane, it’s important to understand how thoroughly the Fed has changed its approach to controlling interest rates (and through that, its relationship with markets). The topic isn’t just for technocrats — the debate now is over whether that change should be a permanent one.
Janet Yellen opened the festivities at this year’s Jackson Hole economic symposium by musing on what central bankers had learned since the crisis and how they can deal with future recessions in a world where interest rates are far lower than in the past. Unsurprisingly, bond-buying and “forward guidance” featured prominently in Yellen’s narrative of successful new tools. (On the other hand, scholars have estimated the combined impact of these measures was an unemployment rate a mere 0.13 percentage points below where it would have been using purely conventional instruments.)
Central bankers in Europe have been thinking a lot about The Death of Banks lately. Not so much in the US. There’s good reason for that, of course. Europe has been bleeding out banks with negative rates, so policy makers there have become painfully aware of the banks’ role implementing monetary policy. The US Federal Reserve, on the other hand, has been keeping banks alive with a steady drip of interest on excess reserves, or IOER, to control rates in a financial system awash with liquidity. The Fed’s releasing a policy statement today (we understand if you forgot about that in the heli-frenzy before the BoJ on Friday). Of course, keeping banks on life support with IOER doesn’t help net interest margins. NIM is a key measure of bank profitability. It’s also closely tied to the US yield curve — which is unfortunate for banks, because that sucker has been positively steamrolled lately by the combination of low yields abroad, low inflation expectations and rising US policy rates.
This is a guest post from Richard Koo, chief economist of the Nomura Research Institute and, amongst many other things, author of “The Holy Grail of Macroeconomics, Lessons from Japan’s Great Recession”, which lays out his balance sheet recession thesis in detail. The post is an updated extract from his most recent note for Nomura and reproduced here, with his permission, for your arguing pleasure… The US, the UK, Japan, and Europe all implemented quantitative easing (QE) policies, but the understanding of how those policies work apparently differs greatly from country to country, leading to very different outcomes. With the US economy doing better than the rest, there has been some debate in Europe as to why that is the case.
Even people who don’t normally find money markets interesting (we’ve heard such baffling types exist) might pause to consider a number like this: $160 trillion. That’s the notional outstanding value of US dollar financial products currently indexed to the London Interbank Offering Rate, or Libor — you remember, that rate survey that was awkwardly riggable.
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:
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.
The newly expanded crew of FT Alphaville’s team in New York will be hosting a special edition of Macro Live this afternoon starting at 1:50pm EST (6:50pm London time). You’ll find us at the usual place. Matt Klein and I will be joined by Alex Scaggs, a recent addition to the Alphaville team, to cover the release of the FOMC statement and the Summary of Economic Projections, after which we’ll follow the presser at 2:30pm.
From the New York Times, November 13, 1979 (please note emphasised text): PARIS – Central banks of the major Western industrial powers have privately agreed on a two-stage plan for controlling the explosive growth of the so-called Eurocurrency markets that they now believe is fuelling world inflation, according to a senior central bank governor closely involved in the discussions. The governors of the central banks are reviewing the new Eurocurrency control scheme at their regular secret monthly meeting at the Bank for International Settlements in Basel. However, they are unlikely to unveil it formally before the end of the year, according to the source.
The first question is whether there was a lovely new, but secret, currency accord agreed at the G20 in Shanghai in February. The answer is: Probably not.
Ben Bernanke first gained the catchy but unfortunate nickname “Helicopter Ben” when he gave a speech in 2002 endorsing Milton Friedman’s idea of a metaphorical helicopter drop of money as an extreme but effective way of combating deflation – a moniker that haunted him when he introduced a $4tn quantitative easing programme at the Federal Reserve. But in his latest blogpost at Brookings he has cautiously endorsed the concept again. While careful not to step on current Fed chair Janet Yellen’s toes by suggesting at all that this is a likely course of action – and the US economy is doing fairly well, if unspectacularly – he now writes that it shouldn’t be ignored as a policy tool:
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 dropof 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.
The biggest news from Wednesday’s Federal Reserve meeting was the sharp decline in the path of future interest rates forecast by policymakers over the next few years. Less noteworthy for its immediate impact, but still significant, was the modest change in the forecast for the level of the Federal funds rate in the “longer run”. Previously, the median policymaker expected short-term interest rates to hover around 3.5 per cent once the economy had returned to normal. Now she thinks the “longer run” level is closer to 3.25 per cent.
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:
Matt Klein and I will be hosting a special edition of Macro Live to cover the release the of the FOMC statement and the Janet Yellen presser. We’ll be starting at 1:55pm EST (that’s 5:55pm in London), and you can join us at the usual place.
By David Beckworth An increasing number of observers believe that the United State is inching closer to a recession. They see the stock market rout, plummeting oil prices, and falling inflation expectations as an ominous sign for the economy. Some also worry that the Fed’s raising of interest rates in December may have gotten ahead of the recovery. They fear this tightening of monetary policy could intensify these other dire developments and be the tipping point that pushes the economy into recession.
Imagine someone told you about a country where real output per person is at an all-time high and growing at an increasingly rapid pace, its employment rate is at the highest level in decades, the country’s housing sector is on fire, and its current account surplus is about 6 per cent of GDP. In the absence of other information, would you say this country should be: If you answered yes to the above questions, congratulations! You’ve just described the behaviour of the Sveriges Riksbank. From their policy announcement on Thursday (our emphasis):
Cardiff and Matt will be live-blogging Janet Yellen’s testimony before Congress. You can find us at the usual place, and we’ll kick things off at 9:58am, just a couple of minutes before the hearing begins. Her opening remarks are here, and the FT’s Sam Fleming previews the testimony here:
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:
Thanks to the tenacity of Congressman Henry Gonzalez, the Federal Reserve has been releasing (mostly) complete transcripts of what was said during policy meetings, including the forecasts and policy options produced by the staff, since the early 1990s. (Ironically, most of the people on the Federal Open Market Committee hadn’t known their meetings were being secretly recorded ever since the mid-1970s.) These transcripts are released with a significant lag, so we’re only now getting insight into the precise debates and thinking of American central bankers in the tumultuous year of 2010. You can read them all here. (You can find our analysis of the 2009 transcripts, released last year, starting here.)
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.
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.