Tuesday, September 30, 2014

Life After QE
Will there be life after QE? The Fed is scheduled to terminate this program at the end of October. There’s no doubt that investors are starting to fret about what comes after QE. They realize that once QE is terminated, all the focus will be on when the Fed will start raising interest rates. So recent comments on this subject by members of the “Federal Open Mouth Committee” seem to be having more impact on daily trading, contributing to the market’s volatility. Consider the following:

(1) Richard Fisher is a retiring hawk. Last Thursday’s 1.6% drop in the S&P 500 was widely attributed to FRB-Dallas President Richard Fisher's warning that interest rates may rise “sooner rather than later.” Of course, he is widely known as a hawk. In fact, he dissented at the last meeting of the FOMC according to the official statement: “President Fisher believed that the continued strengthening of the real economy, improved outlook for labor utilization and for general price stability, and continued signs of financial market excess, will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee's stated forward guidance.”

Fisher said the Fed might start raising rates around the spring of 2015. He won’t be a voting member of the FOMC next year. Actually, he recently announced that he plans to retire next year. In the past, his comments have never had much if any impact on the markets since the Fed’s hawks have been consistently outnumbered by the doves.

(2) Charles Evans is an influential dove. On the other hand, FRB-Chicago President Charles Evans yesterday told CNBC that he believes it would be "quite some time" before it's appropriate to start tightening. Evans is one of the Fed's dovish regional chiefs. While not a voting member on the central bank's policymaking committee this year, he's a 2014 alternate and will be voting next year. He has been an influential dove, convincing the FOMC to tie policy to the unemployment rate in late 2012.

Evans sees June as a possibility for the first rate increase, but said on CNBC’s Squawk Box that if it were his decision, he'd wait even longer. “If you look at the risks, we ought to balance those and be concerned that sometimes coming out of zero [rates] ... is really a difficult proposition for the economies. And so I'd like to be patient.”

(3) James Bullard is a bellwether. Last Tuesday, FRB-SL President James Bullard said that, at the next meeting of the FOMC on October 28-29 (after QE has been terminated), the Fed may need to drop its “considerable time” pledge for when interest rates will rise. He said, “I would like to get the committee to move to something that is more data dependent.” Bullard won’t have a vote on policy until 2016. Nevertheless, an article in Bloomberg recently described him “as a bellwether because his views have sometimes foreshadowed policy changes.”

(4) William Dudley is watching the dollar. Last Wednesday, Bloomberg’s Simon Kennedy reported:
As Federal Reserve Bank of New York president, [William] Dudley is the only regional Fed chief with a permanent vote on policy and is the central bank’s eyes and ears on Wall Street. So when Dudley says something new it’s worth tuning in. And this week he became the first Fed official to comment on the U.S. dollar since the Bloomberg Dollar Spot Index touched its highest level on a closing basis since June 2010.

“If the dollar were to strengthen a lot, it would have consequences for growth," the 61-year-old Dudley, a former Goldman Sachs Group Inc. economist, said at the Bloomberg Markets Most Influential Summit in New York. "We would have poorer trade performance, less exports, more imports,” he said. "And if the dollar were to appreciate a lot, it would tend to dampen inflation. So it would make it harder to achieve our two objectives. So obviously we would take that into account."
The JP Morgan trade-weighted dollar jumped 1% last week to the highest reading since June 7, 2010.

5) “Tightening tantrums” ahead. All this means that we can look forward to spending October wondering (as we did before the September 16-17 meeting of the FOMC) whether “considerable time” will be dropped from the next statement. It probably will be deleted from the Fed’s boilerplate message. In any event, we can expect more “tightening tantrums” ahead. The stock market may be just as freaked out as Evans is by the notion that the economy might go wobbly on the first rate hike.
(Based on an excerpt from YRI Morning Briefing)

Monday, September 22, 2014

Yellen's Spin
Fed Chair Janet Yellen still knows how to sprinkle the fairy dust on the stock market. I’ve noted in the past that ever since she joined the Fed, stock prices usually have moved higher whenever the “Fairy Godmother of the Bull Market” has spoken publicly about monetary policy and the economy.

She first served at the Fed as vice chair of the Board of Governors, taking office in October 2010, when she simultaneously began a 14-year term as a member of the Board that will expire January 31, 2024. Since becoming the Fed chair on February 3, 2014, for a four-year term ending February 3, 2018, her power to charge up the bull has clearly increased. She did it again last week when she spoke at her third press conference as Fed chair after the latest meeting of the FOMC on Wednesday, September 17. The S&P 500 rose 0.6% from the closing price on Tuesday to Thursday’s closing price, hitting yet another new record high of 2011.23.

In my 9/18 Fed Blog post, I discussed Yellen’s “Theory of Relativity.” Here are some additional related points:

(1) The beat goes on. By my count, Yellen has spoken publicly about monetary policy and the economy eight times since assuming the top job at the Fed. The market has rallied every time with one exception, on March 19 when she said at her first press conference that “considerable time” meant about six months. In other words, six months after the projected termination of QE by the end of October, the Fed would start hiking the federal funds rate. That would be April 2015.

(2) Time isn’t measured with a clock. She subsequently backed away from such specific forward guidance. Indeed, during her press conference last week, she reiterated that Fed policy is data dependent, not date dependent: “I know ‘considerable time’ sounds like it's a calendar concept, but it is highly conditional and it's linked to the Committee's assessment of the economy.” As noted in last week’s FOMC statement, as long as the committee judges that “a range of labor market indicators suggests that there remains significant underutilization of labor resources” and that inflation is running below 2.0%-2.5%, Yellen and most of her colleagues are in no rush to raise interest rates.

(3) The “dot plot” is also meaningless. What about the “dot plot” showing the federal funds rate forecasts of all the participants of the FOMC whether they are voting members of the committee or not? The latest one was released along with the FOMC statement last Wednesday. It shows an upward drift from the previous plot released on June 18.

However, as Yellen said at her previous press conferences, the dot plot is as meaningless as “considerable time.” She reiterated that Fed policy is data dependent, suggesting that the forecasts are just a game they play on the FOMC. At her latest press conference, Yellen said over and over again that there is a lot of uncertainty about the Fed’s forecasts, even over the next few quarters, so just ignore the FOMC’s median forecast for where the fed funds rate will be at the end of 2017.

She first minimized the importance of the dot plot at her first press conference as Fed chair on March 19: “But, more generally, I think that one should not look to the dot plot, so to speak, as the primary way in which the Committee wants to or is speaking about policy to the public at large.” She did it again at her second press conference on June 18: “And around each of those dots, I think every participant who’s filling out that questionnaire has a considerable band of uncertainty around their own individual forecast.”

(4) Back to “measured” pace of rate hikes? The FOMC raised the federal funds rate by 25bps at every meeting during the “measured” pace of tightening under Fed Chair Alan Greenspan from May 4, 2004 through December 13, 2006. Last Wednesday, the WSJ MarketWatch posted an interesting analysis of the latest dot plot, showing that it implied rate hikes at every meeting once the Fed starts raising rates again.
(Based on an excerpt from YRI Morning Briefing)

Thursday, September 18, 2014

Yellen's Theory of Relativity
The Fed is in no rush to raise interest rates sooner than Fed watchers expect. Most of them expect the Fed to start doing so next year either in the spring or early summer. So yesterday’s statement retained the “considerable time” language that has been in the FOMC statements since the September 12-13, 2012 meeting of the committee. Back then, the specific sentence stated:
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.
This sentence was tweaked in the December 12, 2012 statement as follows:
To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends.
That program will end at the next meeting on October 28-29. Most Fed watchers seem to believe that six to nine months is a considerable time, which would mean that the first rate hike should be during either April, May, June, or July of next year.

As widely expected, during her press conference, Fed Chair Janet Yellen reiterated that there is room for improvement in the labor market. She noted that while inflation has risen in recent months, it remains below the Fed’s target. Fed policy remains data dependent, which means that the normalization of monetary policy will depend on the performance of the economy. So once the Fed starts raising interest rates, it could happen at a slow pace or at a fast pace.

On balance, there were no surprises yesterday other than for those of us who thought there was a chance that “considerable time” would be dropped. Clearly, Yellen is solidly in charge of FOMC policymaking, and she is among the most dovish members of the committee. In any event, during the Q&A session of the press conference, Yellen said that “considerable time” has nothing to do with time. She stressed that Fed policy is data dependent. So the Fed will hike rates when the data say it’s time to do so, not when the clock says so. In other words, “considerable time” is basically meaningless. Got that?

The Fed will maintain ultra-easy monetary policy as long as the economy needs it, which will depend on the FOMC’s assessment of the incoming data.
(Based on an excerpt from YRI Morning Briefing)