Wednesday, February 25, 2015

Yellen: A Dash of Fairy Dust
There really weren’t any surprises in Fed Chair Janet Yellen’s semiannual congressional testimony and report on monetary policy yesterday. She signaled that while the normalization of monetary policy might begin around mid-year, the FOMC is likely to do so very gradually. Both stock and bond prices responded positively. The S&P 500 rose to 2115, another record high. The Nasdaq rose to 4968, only 1.6% below its record high of 5048 on March 10, 2000. Let’s review what she had to say:

(1) Labor market. Fed policy remains dependent on “incoming data.” Despite the awesome employment report released on February 6, Yellen said in her prepared remarks that “a high degree of policy accommodation remains appropriate to foster further improvement in labor market conditions and to promote a return of inflation toward 2 percent over the medium term.”

(2) “Patient.”. She didn’t say when or under what conditions the word “patient” would be deleted from the FOMC’s forward guidance. However, she reiterated that the “FOMC's assessment that it can be patient in beginning to normalize policy means that the Committee considers it unlikely that economic conditions will warrant an increase in the target range for the federal funds rate for at least the next couple of FOMC meetings.”

This does suggest that the word could be dropped from the March 18 statement if the FOMC anticipates liftoff at the June 16-17 meeting. I still think the FOMC might keep the word, but change its context to suggest that the Fed will be patient about raising interest rates further after the first rate hike.

(3) Normalization. Now, I challenge you to decipher the following from Yellen’s prepared remarks, which seems to have been written in Greenspan-speak:
If economic conditions continue to improve, as the Committee anticipates, the Committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis. Before then, the Committee will change its forward guidance. However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the Committee will necessarily increase the target range in a couple of meetings. Instead the modification should be understood as reflecting the Committee's judgment that conditions have improved to the point where it will soon be the case that a change in the target range could be warranted at any meeting. Provided that labor market conditions continue to improve and further improvement is expected, the Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when, on the basis of incoming data, the Committee is reasonably confident that inflation will move back over the medium term toward our 2 percent objective.
The main point seems to be that the FOMC might continue to normalize monetary policy even if inflation remains below 2%, as long as the committee expects it will move back up there in a reasonable time.

However, the federal funds rate is likely to remain below “normal” for quite some time:
It continues to be the FOMC's assessment that even after employment and inflation are near levels consistent with our dual mandate, economic conditions may, for some time, warrant keeping the federal funds rate below levels the Committee views as normal in the longer run. It is possible, for example, that it may be necessary for the federal funds rate to run temporarily below its normal longer-run level because the residual effects of the financial crisis may continue to weigh on economic activity
(4) Bubbles. In her prepared remarks during her previous semiannual testimony on July 15, 2014, Yellen mentioned that she had some concerns about speculative excesses as some investors “reach for yield.” She didn’t mention that this time. However, the formal report observed:
Overall equity valuations by some conventional measures are somewhat higher than their historical average levels, and valuation metrics in some sectors continue to appear stretched relative to historical norms.
There was no specific mention of stretched valuations for smaller firms in the social media and biotechnology industries, as there was in the July 2014 report. Back then, overall valuations seemed consistent with historical norms for the prices of real estate, equities, and corporate bonds
(Based on an excerpt from YRI Morning Briefing)

Tuesday, February 24, 2015

Yellen: Shades of Grey
Fed Chair Janet Yellen and I have something in common. We both studied under Professor James Tobin, a Nobel laureate, in the graduate economics department at Yale University. She graduated with a PhD degree six years before I did. I actually studied from a Xerox copy of the neat and meticulous notes she took in Tobin’s course on macroeconomics. They were called the “Yellen notes.” We also both have grey hair, though I have more shades of grey.

Today and tomorrow, Yellen will testify before two congressional committees on monetary policy. It will be interesting to see how she shades the outlook for Fed policy. The minutes of the January 27-28 FOMC meeting, released last Wednesday, was widely perceived to be dovish, suggesting that the committee’s members are in no rush to raise interest rates. They remained “patient.” However, on February 6, January’s employment report was so strong that everyone concluded that the Fed will commence “lift-off” at the June 16-17 meeting of the FOMC.

That means that the FOMC will have to decide whether to drop the “patient” clause in either the March 18 or April 29 statement to prepare the markets for a rate hike on June 17. The latest minutes noted:
Many participants regarded dropping the ‘patient’ language in the statement, whenever that might occur, as risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates. As a result, some expressed the concern that financial markets might overreact, resulting in undesirably tight financial conditions.
My hunch is that Yellen will suggest that labor market conditions have improved sufficiently so that the FOMC can proceed with the first rate hike at mid-year. However, she is likely to also say that the Fed will remain patient about further rate hikes, increasing the likelihood of “one-and-done” for this year. Here is a possible scenario for the evolution of the “patient” clause in the FOMC statements:

(1) Dec.17 actual:
Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October …
(This was the first time that the word “patient” appeared in the statement.)

(2) Jan. 28 actual:
Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.
(This was the first time that the “considerable time” phrase was deleted from the statement since it first appeared in this context on September 13, 2012.)

(3) Apr. 29 hypothetical:
Based on its current assessment, the Committee judges that it can be patient in normalizing the stance of monetary policy once it begins.
(In other words, rate hikes will begin soon, but will proceed at a patient pace. That would be similar to, but more gradual than, the “measured pace” of tightening from June 30, 2004 to June 29, 2006.)

If that’s the way things go, then stock prices should continue to move higher. They could even melt up. That’s especially likely if Yellen doesn’t mention any serious concerns about overvaluation in the financial markets as she did during her July 15, 2014 semiannual monetary policy testimony to Congress. Back then, she said in her prepared remarks:
The [FOMC] Committee recognizes that low interest rates may provide incentives for some investors to ‘reach for yield,’ and those actions could increase vulnerabilities in the financial system to adverse events. While prices of real estate, equities, and corporate bonds have risen appreciably and valuation metrics have increased, they remain generally in line with historical norms. In some sectors, such as lower-rated corporate debt, valuations appear stretched and issuance has been brisk. Accordingly, we are closely monitoring developments in the leveraged loan market and are working to enhance the effectiveness of our supervisory guidance.
The monetary policy report that accompanied her testimony specifically noted:
Nevertheless, valuation metrics in some sectors do appear substantially stretched--particularly those for smaller firms in the social media and biotechnology industries, despite a notable downturn in equity prices for such firms early in the year.
Previously, I’ve noted on numerous occasions that Yellen has been the “Fairy Godmother of the Bull Market.” The S&P 500 has tended to rise after she spoke publicly about monetary policy and the economy. Let’s see if she sprinkles more fairy dust today and tomorrow.

By the way, Jon Hilsenrath, the WSJ’s ace Fed watcher, observed last Thursday that the latest minutes weren’t as dovish as widely believed:
The central bank held a special ‘policy planning’ session to discuss the appropriate timing of interest rate increases. Officials had a long and detailed briefing from staff on the tools it would use once it started raising interest rates. In addition the staff briefed officials on the alternate interest rate paths it might choose for a series of interest rate increases, with historical and international comparisons. Moreover officials discussed removing the assurance from its policy statement that it will be patient before raising rates. Fed Chairwoman Janet Yellen is a methodical planner known since her childhood for doing her homework. Her Fed has clearly entered an intensive planning stage for interest rate increases.
(Based on an excerpt from YRI Morning Briefing)

Monday, February 23, 2015

Central Banks: Market Dependent
Central banks have added “forward guidance” to their bag of monetary policy tools since the financial crisis of 2008. The idea has been to guide financial markets in the desired direction without any surprises that might trigger financial turmoil.

Central bankers, particularly the ones at the Fed, have consistently declared that their policy moves will be “data dependent.” That makes forward guidance a very questionable exercise in practice because communicating it can very quickly degenerate into the old joke about economists, as first delivered by President Harry S. Truman: “Give me a one-handed economist! All my economists say, ‘On the one hand, on the other.’”

Making the situation even more amusing is that both the Fed and ECB have stated that their policymaking is also market dependent--on the third hand. That approach can easily (and can often) conflict with the data-dependent approach. Or at least it can be very confusing. In other words, there may be (and have been) plenty of times when no guidance might be better than forward guidance. Consider the following:

(1) Fed. There are certainly lots of two-handed economists at the Fed. Their two-handed guidance was most recently expressed in the 1/28 FOMC statement:
Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.
What an amazing insight! The full minutes of the 1/28 FOMC meeting included the following punch line:
It was also suggested that maintaining the federal funds rate at its effective lower bound for an extended period or raising it rapidly, if that proved necessary, could adversely affect financial stability.
In other words, policy needs to be market dependent, i.e., it needs to factor in the likely market reaction to policy changes.

The minutes indicated that the FOMC may have some regrets about using the word “patient” in the previous statement and using it again in the latest one:
Many participants regarded dropping the ‘patient’ language in the statement, whenever that might occur, as risking a shift in market expectations for the beginning of policy firming toward an unduly narrow range of dates. As a result, some expressed the concern that financial markets might overreact, resulting in undesirably tight financial conditions.
Again, monetary policy is market dependent, not just data dependent.

Apparently, the FOMC is no longer amused by forward guidance and looking forward to ending it:
A number of participants noted that while forward guidance had been a very useful tool under the extraordinary conditions of recent years, as the start of normalization approaches, there would be limits to the specificity that the Committee could provide about its timing. Looking ahead, some participants highlighted the potential benefits of streamlining the Committee's postmeeting statement once normalization has begun.
In other words, there might be less guidance in the future.

(2) ECB. Following its meeting on July 4, 2013, the ECB’s Governing Council communicated that it expects the key ECB interest rates to remain at present or lower levels for an extended period of time. According to the ECB’s Monthly Bulletin:
The Governing Council’s expectation is based on the overall subdued outlook for inflation extending into the medium term, given the broad-based weakness in the real economy and subdued monetary dynamics. At the current juncture, forward guidance contributes to the ECB’s pursuit of its mandate of maintaining price stability effectively, within the framework and in full respect of its strategy.
At its June 5 meeting last year, the ECB cut the rate on its deposit facility for banks from 0.00% to minus 0.10%--the first time that a major global central bank has moved rates into negative territory. On January 22, the ECB announced a QE program that will start buying €60 billion per month in bonds during March until at least September 2016.

Last Thursday, for the first time ever, the ECB released the minutes of the Governing Council’s meeting. At the latest one on January 22, the members of the committee were aware that QE largely was priced into financial markets, and were concerned about the potential fallout if they didn’t deliver:
A large part of the very substantial financial price adjustment observed over recent weeks would most likely rapidly unwind if no monetary policy action were taken at the current meeting.
Policymaking is market dependent, not just data dependent.

(3) BOJ. Last Wednesday, Bank of Japan Governor Haruhiko Kuroda focused on the currency market’s reaction to QQE, which was introduced on April 4, 2013 and extended with QQEE on October 31, 2014. He ruled out additional near-term monetary easing in an effort to stabilize the yen, which may have fallen too much. It is down roughly 35% relative to the dollar since late 2012. That’s been great for exporters. But it has also depressed consumer spending by boosting import prices.

(4) PBOC. The People’s Bank of China is also watching the currency markets. Chinese officials, who have been pegging the yuan to the US dollar, must be increasingly concerned about the strength of their currency relative to the euro and the yen. This, along with weakening economic data, explains why the PBOC lowered interest rates last November and reserve requirements in January.
(Based on an excerpt from YRI Morning Briefing)

Thursday, February 19, 2015

Futures Forecast
January’s stronger-than-expected employment report, which was released on February 6, refocused fixed-income investors on the rising odds of a first Fed rate hike at the June 16-17 meeting of the FOMC. The 10-year Treasury bond yield is up from 1.83% on February 5 to 2.14% on Tuesday of this week. Yesterday’s release of the January 27-28 FOMC minutes, which was relatively dovish, eased the yield back down to 2.08%.

Of course, the meeting occurred before the release of February’s strong employment data. In addition, economic indicators out of Germany and Japan showed some improvement since the meeting. The price of oil has also rebounded in recent weeks. Several members of the FOMC have subsequently said that they would favor a mid-year rate hike.

The implied federal funds rate based on futures contracts traded on the CME rose sharply following January’s employment report. The 12-month contract jumped from 0.52% on February 5 to 0.66% currently. The six-month implied fed funds rate is 0.25%.

These forecasts are consistent with our one-and-done scenario for Fed rate hikes this year. So are the latest relatively dovish minutes. Here are a few key excerpts:
(1) Many participants indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.

(2) There was wide agreement that it would be difficult to specify in advance an exhaustive list of economic indicators and the values that these indicators would need to take. Nonetheless, a number of participants suggested that they would need to see further improvement in labor market conditions and data pointing to continued growth in real activity at a pace sufficient to support additional labor market gains before beginning policy normalization.

(3) A number of participants emphasized that they would need to see either an increase in market-based measures of inflation compensation or evidence that continued low readings on these measures did not constitute grounds for concern.

(4) Several participants indicated that signs of improvements in labor compensation would be an important signal, while a few others deemphasized the value of labor compensation data for judging incipient inflation pressures in light of the loose short-run empirical connection between wage and price inflation.
(Based on an excerpt from YRI Morning Briefing)

Monday, February 9, 2015

Game Changer?
Friday’s employment report was so strong that everyone came to the same conclusion at the same time: The FOMC will most likely start hiking the federal funds rate at the June 16-17 meeting of the monetary policy committee. Wage increases remain subdued, and lower than Fed officials would like to see. However, the recent impressive payroll employment gains are reminiscent of the good old days of the Old Normal economy. It’s hard to imagine the Fed coming up with any more credible excuses for not moving forward with monetary normalization given that the labor market has been moving back to normal so fast in recent months.

The question is whether the first rate hike will be followed by additional ones this year or whether one-and-done is still the most likely scenario for 2015, as Debbie and I have been thinking. It all depends on the strength of the dollar. With the Fed moving to tighten monetary policy while the other major central banks are moving in the other direction, the dollar should continue to soar. The trade-weighted dollar has had a vertical ascent, rising 14% since July 1, 2014. It could rise by another 10% in the one-and-done scenario.

That could push the US inflation rate further below the Fed’s 2% target. It could also depress US exports and boost US imports. So the trade deficit would weigh on real GDP growth, as it did during Q4-2014. The Fed might be satisfied with one rate hike at mid-year in this scenario, and then remain patient about further increases until next year.

In any event, Fed Chair Janet Yellen will spin it all together for us in her semi-annual congressional testimony on monetary policy scheduled for February 24 before the Senate Banking Committee and the next day before the House Financial Services Committee. She’ll probably say that employment gains are so strong that she and most of the other members of the FOMC anticipate that price and wage inflation should rise later this year closer to the Fed’s targets.

She is likely to say that the Fed remains “patient” about raising rates, but less so now than when the word first appeared in the January 28 FOMC statement. That would imply that the word could be dropped even from the next statement on March 18, and almost certainly from the April 29 statement. Then the June 17 statement should announce that the game of hiking rates has begun.
(Based on an excerpt from YRI Morning Briefing)

Friday, January 30, 2015

How the World Works
Why hasn’t ultra-easy monetary policy revived global economic growth? Why is the global economy increasingly mired in secular stagnation despite record-low interest rates and the flood of central bank liquidity? Last year, the supply of global liquidity, measured as the sum of non-gold international reserves held by all central banks plus the Fed’s holdings of US Treasuries and Agencies, rose to a record $16.6 trillion during August. That’s up $8.7 trillion, or 116%, since the start of 2009.

Central banks responded to the financial crisis of 2008 by pumping lots of liquidity into the global economy since then. They also lowered their official interest rates close to zero, with some of them now below zero. Bond yields are at historical lows in most of the major advanced economies. Rather than deleveraging, borrowers around the world were enabled by the central banks to borrow more.

The problem is that easy money has been around for a long time, and seems to be losing its effectiveness in stimulating economic growth. During the previous two decades, many of the borrowers were consumers of commodities, goods, and services. Their debt-financed spending boosted economic growth. That encouraged producers to expand their capacity by borrowing as well. In recent years, easy money seems to have lost its ability to boost consumption, while enabling producers to stay in business.

The result has been mounting deflationary pressures. The major central bankers have responded by lowering their interest rates to zero and providing more liquidity through various QE programs. They’ve been doing so since the financial crisis. That’s more than six years, yet secular stagnation seems to be spreading along with deflationary forces around the world.

In addition, populist politicians are gaining power, especially in the Eurozone and particularly in Greece. They want to end their governments’ austerity measures. In other words, they want to reduce the burden of the debts that their countries and countrymen accumulated during the so-called “debt super-cycle” of the past couple of decades. That means restructuring their debts by forcing lenders to extend maturities, to lower borrowing rates, to take haircuts, or to accept defaults. Of course, the last option is the one that would put a stake in the heart of the debt super-cycle and destroy the credibility of the central banks.

Is there a solution to this mess? Beats me. Central banks have been going down this road for a long time. They are likely to continue doing what they have been doing without recognizing how they might have inadvertently created the mess. Their mess has spread to the foreign exchange market, triggering an undeclared currency war. The central bankers have declared that their ultra-easy monetary policies aren’t aimed at driving down their currencies, but that’s what they are doing.

The Bank of Japan’s contribution to Abenomics was to devalue the yen with its QQE program. The currency plunged 34% from September 13, 2012 through yesterday. ECB President Mario Draghi started talking the euro down late last summer, and pushed it lower with the QE program announced last week. The euro is down 19% from last year’s high on May 6. Commodity currencies are plunging around the world because the commodity super-cycle wasn’t as super as many producers had anticipated when they expanded their capacity.

Instead of fretting over where this is all leading, let’s take a brief stroll down Memory Lane to recall how we got here:

(1) Fed. The Fed provided lots of easy money since the late 1980s. Under Fed Chair Alan Greenspan, the result was a bubble in high-tech stock prices during the late 1990s and a housing bubble during the previous decade. Under Fed Chair Ben Bernanke and now Janet Yellen, bond and stock prices have soared. Home prices have recovered.

The economy finally seems strong enough that Fed officials are aiming to start raising interest rates at mid-year. The problem is that the soaring dollar is pushing inflation further below the Fed’s 2% target. In addition, it is depressing corporate profits, causing companies to reduce their labor costs, which may continue to keep wage inflation around 2%, below the Fed’s 3%-4% preference.

This increases the likelihood of either one-and-done or none-and-done for rate-hiking this year. Yesterday’s FOMC statement reiterated: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.” The word “patient” is ambiguous enough that the FOMC dropped the “considerable time” phrase without upsetting the markets yesterday.

(2) ECB. The introduction of the euro at the start of 1999 caused bond yields to converge in the Eurozone as investors no longer distinguished between the credit risk of the different members of the monetary union.

The spread between both Spanish and Italian government bond yields versus the comparable German yield narrowed to zero during the previous decade. Spreads widened again at the beginning of the current decade, but narrowed significantly after Mario Draghi pledged to do whatever it takes to defend the euro on July 26, 2012.

ECB data show that loans to the Eurozone private sector soared by €4.0 trillion to a record €11.1 trillion from the start of 2004 through the end of 2011. As of November 2014, this debt measure was down to €10.4 trillion. In other words, the ECB’s various attempts to revive lending since the financial crisis have failed. That might be because borrowers are already maxed out on their ability to service more debt.

(3) PBOC. The Chinese responded quickly to the financial crisis of 2008 with a large fiscal stimulus program and lots of easy money. Banks were encouraged to lend freely, which they did. Bank loans soared by $8.9 trillion from the end 2008 to a record high of $13.3 trillion at the end of last year. Yet China’s economic growth continues to slow as the economy gets less bang-per-yuan of borrowing.

(4) BOJ. Last Wednesday, the BOJ monetary policy committee cut its core inflation forecast to 1.0% for the fiscal year starting in April from 1.7%. Despite the latest QE (introduced on April 4, 2013) and then QQE (October 31, 2014) under Abenomics, Japan’s monetary policymakers can’t seem to get core inflation up to 2%.

The BOJ has succeeded in devaluing the yen and boosting stock prices. But it is distorting the bond market. Thanks to QQE purchases by the BOJ, the Japanese 10-year government bond yield was down to only 0.28% yesterday. The 30-year yield was 1.29%. The flattening of the yield curve near zero is bad news for financial companies, especially insurance companies and banks.

Already some forex watchers are watching out for a Swiss-style jump in the yen if the BOJ finds that it’s getting harder to buy JGBs because no one wants to sell them.
(Based on an excerpt from YRI Morning Briefing)

Monday, January 26, 2015

Q€ for Geeks & Greeks
The ECB’s decision last Thursday to implement Q€ wasn’t a surprise. Nevertheless, the details of the plan as presented by ECB President Mario Draghi in his follow-up press conference provided some shock-and-awe to global financial markets. Let’s review the key elements of the program:

(1) Bigger size. Before the meeting of the ECB’s Governing Council on Thursday, the financial press was full of stories reporting that unnamed sources said that bond purchases would be €50 billion per month. Draghi said the purchases would be €60 billion per month starting in March through the end of September 2016. That would add €1.1 trillion to the ECB’s balance sheet over that period. Draghi said that this purchase program includes the existing one for asset-backed securities and covered bonds, which is around €10 billion per month.

(2) Open-ended. The big surprise was that the program might continue beyond September 2016. Draghi said that the purchases “will in any case be conducted until we see a sustained adjustment in the path of inflation which is consistent with our aim of achieving inflation rates below, but close to, 2% over the medium term.”

(3) Long bonds. As noted above, Draghi said that the maturities of the bonds purchased by the ECB would be between two years and 30 years. That certainly exposes the central bank to some risk if it succeeds in boosting inflation back to 2%, since yields would rise in that scenario. No one asked Draghi about that at the press conference.

(4) Risk sharing. The bulk of the bond purchases will be by the national central banks (NCBs) under the direction of the ECB. The NCBs and ECB will share any losses attributable to the securities of European institutions, which will account for 12% of Q€ assets. The same goes for an additional 8% of additional assets that will be held by the ECB. According to the press release: “This implies that 20% of the additional asset purchases will be subject to a regime of risk sharing.” In other words, the NCBs will be at risk on their own for 80% of the assets purchased under the program. That shows the contortions that were necessary to get the deal done.

(5) Immaculate conception. Incredibly, notwithstanding the historic significance of the ECB’s Q€ and the ongoing controversy about it, particularly in Germany, the Governing Council adopted it without a formal vote. Draghi said that “there was a large majority on the need to trigger it now, and so large that we didn’t need to take a vote.” In other words, none of the members wanted to be on the record as having voted for it! Indeed, there was “a good discussion” on whether it needed to be implemented right away.

(6) Greasing Greece. Draghi was asked whether or not the ECB will purchase Greek debt. He responded as follows: “We don't have any special rule for Greece. We have basically rules that apply to everybody. There are obviously some conditions before we can buy Greek bonds. As you know, there is a waiver that has to remain in place, has to be a program. And then there is this 33% issuer limit, which means that, if all the other conditions are in place, we could buy bonds in, I believe, July, because by then there will be some large redemptions of SMP bonds and therefore we would be within the limit.”

In Sunday’s election, Alexis Tsipras’s Coalition of the Radical Left, known by its Greek acronym of “Syriza,” took 36.5% of the vote compared with 27.7% for Prime Minister Antonis Samaras’s New Democracy, according to official projections. Campaigning on an anti-austerity program, Tsipras pledged to negotiate a write-down of Greek debt and to abandon budget constraints that were imposed in return for aid. Samaras warned that would risk Greece’s exit from the Eurozone.

The return of Grexit fears could increase financial stress in the region again, and offset whatever stimulative impact Q€ might have. On the other hand, it could send the euro down faster to parity with the dollar.

The big question, of course, is will Q€ work, barring a Grexit? It’s possible, though not very likely, in my view. The Eurozone’s economy has been stagnating since 2011. Interest rates had already fallen sharply since Draghi’s whatever-it-takes sermon on July 26, 2012. It’s not obvious how Q€ will boost bank lending, which is a much more important source of funds for borrowers than the capital markets in the Eurozone. However, the sharp drop in the euro only started last summer, and it might lift Eurozone exports.
(Based on an excerpt from YRI Morning Briefing)

Wednesday, January 14, 2015

Two More Patient FOMC Officials
On Monday, Bloomberg reported that both FRB-San Francisco President John Williams and FRB-Atlanta President Dennis Lockhart expect to vote on the FOMC to start raising interest rates around mid-year. The minutes of the December 16-17 FOMC meeting suggested that lift-off could start at the April 28-29 meeting. More likely now is that the statement released immediately after that meeting might prepare the financial markets for such a decision at the June 16-17 meeting, which will be followed by a press conference with Fed Chair Janet Yellen.

However, Williams, who was the director of research when Yellen ran the FRB-SF until he succeeded his boss when she left during March 2011, hedged his bet, saying in the phone interview with Bloomberg:
I would expect by June that the argument pro and con for lifting off rates will be probably a close call. … If inflation data come in significantly softer than expected and we’re not seeing some kind of better growth in wages, those are clearly factors that I’d be taking into consideration in the timing of liftoff.
In a speech in Atlanta on Monday, Lockhart said:
At the recent meeting of the FOMC in December, the Committee made an adjustment of its forward guidance by introducing the theme of patience in beginning to normalize the stance of policy. I supported and expect to continue to support a patient approach, one that is relatively cautious and conservative as regards the pace of normalization of rates.
(Based on an excerpt from YRI Morning Briefing)

Monday, January 12, 2015

Fairy Godfather
For quite a while, I’ve described Fed Chair Janet Yellen as the “Fairy Godmother of the Bull Market.” Apparently, FRB-Chicago President Charles Evans aspires to be the “Fairy Godfather of the Bull Market.” He certainly was last Thursday when the S&P 500 soared 1.8% on news reports that he said, “I don’t think we should be in a hurry to increase interest rates.” Evans said so during a discussion at the University of Chicago. Later in the presentation, he said such a move to tighten too soon would be a “catastrophe.” He appeared Friday morning on CNBC to give us all the opportunity to hear the same basic message directly from him.

He was interviewed right after the release of December’s employment report, which showed that the jobless rate fell to 5.6% from 5.8% the month before. That’s the lowest since June 2008. The short-term unemployment rate fell to 3.8%, the lowest since November 2007. However, Evans focused on average hourly earnings, which fell 0.2% m/m during December and was up only 1.7% y/y, the lowest since October 2012. He reiterated that he prefers to be “patient” before raising interest rates until wage inflation moves higher and price inflation rises back up to 2%.

On a few occasions late last year, I wrote that Evans is an important FOMC member. He is a voter this year on the FOMC. He is among the most dovish members of the committee. His views very often coincide with those of fellow doves Fed Chair Janet Yellen and FRB-NY President Bill Dudley. Evans first publicly counselled a “patient” approach to monetary normalization in a CNBC interview on 9/29 last year. Lo and behold, that word appeared for the first time in the 12/17 FOMC statement last year: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.” The phrase also appeared three times in the minutes of that meeting, which was released last Wednesday. Let’s review some of its highlights:

(1) Interestingly, the dollar continued to soar on Thursday despite Evan’s suggestion that the Fed’s lift-off of interest rates should be postponed. That might be because the minutes reported:
With lower energy prices and the stronger dollar likely to keep inflation below target for some time, it was noted that the Committee might begin normalization at a time when core inflation was near current levels, although in that circumstance participants would want to be reasonably confident that inflation will move back toward 2 percent over time.
In other words, the Fed might be less patient than Evans would like. I am betting on Evans, which is why I think "one-and-done," or even "none-and-done," is more likely than normalization, i.e., a series of rate hikes later this year.

(2) The minutes defined the FOMC’s patience as follows:
Most participants thought the reference to patience indicated that the Committee was unlikely to begin the normalization process for at least the next couple of meetings.
That confirmed Yellen’s view on this subject, which she expressed at her 12/17 press conference. The next two meetings are on January 27-28 and March 17-18. So normalization might begin at the April 28-29 meeting, though I doubt it.

(3) I think that the strong dollar and weak overseas economic growth may increase the Fed’s patience. The minutes noted:
Many participants regarded the international situation as an important source of downside risks to domestic real activity and employment, particularly if declines in oil prices and the persistence of weak economic growth abroad had a substantial negative effect on global financial markets or if foreign policy responses were insufficient.
Exports of goods now account for 9.3% of current dollar GDP, up from 6.8% ten years ago. Real merchandise exports remained on an upward trend during November, rising 2.6% y/y. Some of the recent strength was attributable to exports of petroleum products, which are likely to decline as US production falls along with oil prices. If the dollar continues to strengthen and global economic growth remains lackluster, other exports might start to weaken too.

The Fed’s patience is also likely to persist as long as wage inflation remains around 2% rather than rising to 3%-4% as Yellen previously said she would like to see happen. As noted above, Evans is concerned that it actually declined to 1.7% y/y during December. So it’s heading in the wrong direction.

A 1/9 Bloomberg article on this subject titled “The Wage Weakness May Not Be as Bad as It Seems” reports: “Stores and online merchants hired a larger-than-usual army of seasonal workers to help keep up with the demand for holiday gift-giving. Amazon.com Inc. prepared for the crush this year by adding 80,000 seasonal workers, up from 70,000 last year.”

FRB-Atlanta Fed President Dennis Lockhart in an interview with Bloomberg news on Friday said, “I am prepared to look at the earnings numbers as potentially noise or month-to-month fluctuations that are not really telling of any condition in the economy that we have to worry about.” Yet he too is willing to be patient: “I don’t see a reason yet to accelerate my assumption of when a policy move might be appropriate.” He also gets to vote on the FOMC this year.
(Based on an excerpt from YRI Morning Briefing)

Friday, December 19, 2014

The Fed Is Patient
Thank you, Janet Yellen! You didn’t disappoint me. You are still the “Fairy Godmother of the Bull Market!” As I’ve noted many times before, the S&P 500 tends to rise after Yellen speaks about the economy and monetary policy. The S&P 500 soared 4.5% on Wednesday and Thursday in response to the dovish FOMC statement and Yellen’s bullish press conference.

On Wednesday, I wrote:
However, the plunge in oil prices and the turmoil in the junk bond market might increase the likelihood that the Fed will delay the so-called "lift-off" of interest rates beyond mid-2015. "None and done" in 2015 is a distinct possibility for Fed policy. Let’s see what Fed Chair Janet Yellen has to say later today. I’m counting on her to continue to be the "Fairy Godmother of the Bull Market.”
On Tuesday, I wrote, “The FOMC might surprise us and keep ‘considerable time’ in the statement.” I noted that inflationary expectations are falling. I also wrote:
The distress in the junk bond market might also dissuade the FOMC from changing the "considerable time" language. In any case, Fed Chair Janet Yellen’s press conference on Wednesday afternoon could have a big impact on the markets. I’m still betting that she is the "Fairy Godmother of the Bull Market.”
On Monday, I noted that FRB-Chicago President Charles Evans, one of the Fed’s uber-doves, has called on his colleagues to be patient and to delay raising interest rates.

Wednesday’s FOMC statement confirmed my analysis:
Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy. The Committee sees this guidance as consistent with its previous statement that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program in October, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.
The FOMC remains dovish and patient. It will be even more dovish and patient next year when Evans will be a voter. Two of the three dissenters (Richard Fisher and Charles Plosser) were hawks, who are retiring. The FOMC has to be concerned about the financial stresses caused by the plunge in oil prices and the strength of the dollar, as evidenced by the spike in junk bond yields and the selloffs in the bonds, stocks, and currencies of emerging economies. That’s why they are willing to be patient for a considerable time longer.
(Based on an excerpt from YRI Morning Briefing)