Central Banks

Janet Yellen

Janet Yellen, Fed chair  © Getty Images

This week has seen speculation about a mutiny from two members of the Federal Reserve’s board of governors against the leadership of Janet Yellen and Stanley Fischer, both of whom continue to say that they “expect” US rates to rise before the end of the year. Although “mutiny” is a strong term to describe differences of opinion in the contemplative corridors of the Fed, there is little doubt that the institution is now seriously split on the direction of monetary policy.

Furthermore, these splits could extend well beyond the date of the first rate hike to the entire path for rates in the next few years. Ms Yellen faces an unenviable task in finding a compromise path that both sides of the Federal Open Market Committee can support. Read more

In the aftermath of the supposedly “weak” US employment data published last week, investors seem to have shifted their assessment of the likelihood of the US Federal Reserve tightening interest rates by December — and also of the extent of tightening in the next two years.

Since the data were published, several investment banks’ economics teams have ruled out a December rise. Furthermore, equities have been strong; and the bond market’s implied probability of a 25 basis points rise in the federal funds rate by December has fallen from 76 per cent in mid-September to only about 40 per cent.

Nor is this seen as a minor postponement in the first rate rise. The expected federal funds rate at the end of 2016 implies only two Fed rate hikes in total over that entire period. Clearly, investors increasingly believe that the US economy is now slowing enough to throw the Fed off course.

This big change in market opinion is, frankly, surprising. The rise of 142,000 in non-farm payrolls in September was not all that weak, given the normal random fluctuations in the monthly data. And as John Williams, president of the San Francisco Fed, has pointed out, a slowdown to a monthly rate of increase of under 200,000 was long overdue anyway. Rightly or wrongly, there is little indication so far that important Federal Open Market Committee members share the market’s increased post-jobs-data dovishness.

The crucial question is how much growth in the US has slowed since the middle of the year, and whether this will continue. This is the kind of question that economic “nowcasts” are best suited to answer, so let us examine the recent evidence. Read more

The deleveraging of the Chinese economy has always seemed likely to be a long and troublesome saga, lasting many years or even decades if it is to prove successful. The latest episode involves a sudden collapse in domestic “A” shares, which have dropped by 19 per cent in less than a fortnight, and have triggered what has been widely described as an “emergency” easing in monetary policy this weekend. Read more

Lord Jim O’Neill, formerly my colleague and chief economist at Goldman Sachs, has just delivered his maiden speech as the new commercial secretary at the UK Treasury. He said that one of the government’s “primary objectives is to deliver a step change in the nation’s productivity”. Even for him, this represents a tough challenge. After featuring barely at all in the recent election campaign, low productivity growth has rightly become public enemy No 1.

Falling productivity growth has been an increasingly serious problem for most advanced economies since the early 2000s, when the boost from IT seems to have run out of steam. But the problem has been particularly severe since the 2008 financial crash, and the collapse in the UK since then has been much greater than in other advanced economies.

Overall, UK productivity had fallen about 16 percentage points below its previous trends by 2014, about a quarter of which might be due to faulty measurement in the official data. If the UK government is to make any inroads into the problem, it first needs to solve the “puzzle” of why the rest of this huge shortfall has occurred. Read more

Ever since the crash in 2008, the central banks in the advanced economies have had but one obsession — how to set monetary policy to ensure the maximum growth rate in aggregate demand. Interest rates at the zero lower bound, followed by a massive increase in their balance sheets, was the answer they conjured up.

Now, those central banks contemplating an exit from these policies, primarily the US Federal Reserve and the Bank of England, are turning their attention to the supply side of their economies. When, they are asking, will output reach the ceiling imposed by the supply potential of the economy?

The Bank of England has been in the lead here, with the Monetary Policy Committee recently conducting a special study of the supply side in the UK. Its conclusion was that gross domestic product is now only 0.5 per cent below potential, which implies that tighter monetary policy will soon be needed if GDP growth remains above potential for much longer.

In the US, the Fed has been much less specific than that, but the unemployment rate has now fallen very close to its estimate of the natural rate (5.0-5.2 per cent). Sven Jari Stehn of Goldman Sachs has used the Fed staffers’ supply side models to calculate that their implied estimate of the US output gap may be only 0.6 per cent, not far from the UK figure.

If the UK and US central banks were to act on these calculations, the implication would be that they no longer hold out much hope that they can ever regain the loss in potential output that has occurred in the past decade, relative to previous trends. That would be a massive admission, with an enormous implied sacrifice in future output levels if they are wrong. It would also be very worrying for financial assets, since it would draw the market’s attention to a downgrade in the Fed’s estimation of the long-run path for GDP. Read more

Downturn In Oil Prices Rattles Texas Oil Economy

  © Getty Images

Ever since the collapse in oil prices started last summer, the behaviour of the global economy and financial markets has been heavily affected by the consequences of lower energy prices. Now, however, there is gathering evidence that the primary effects of the oil shock have been absorbed into the system, and there are signs that other forces are beginning to take control. What are these forces, and how will they affect the global economy in the months ahead?

When the oil shock reached its maximum early in 2015, economists were largely agreed on its likely impact. Since it seemed to stem mainly from the supply side of the oil market, not the demand side (a fact corroborated by IMF research last week), it was thought likely to boost real global GDP growth this year by about 0.5-0.75 per cent, leading to a break-out in global growth to the upside. It also had a dark side, increasing the deflation threat in the eurozone and Japan, but this was likely to be offset by further aggressive monetary easing by their respective central banks. Read more

Yellen Discusses Monetary Policy At Federal Reserve Bank In San Francisco

  © Getty Images

Now that the Federal Reserve has announced that its policy stance after June will be entirely “data determined”, the markets are watching the flow of information on US economic activity even more carefully than usual. Since 2010, there has been a recurring pattern in US GDP projections. They start optimistically, but are then progressively downgraded as the economic data come in.

Entering 2015, I was fairly confident that this depressing pattern would finally be overcome, but not so far. In the last few weeks, there has been a sharp downward adjustment to GDP growth estimates for the first quarter, and this has added to the market’s scepticism about whether the Fed will be ready to announce lift off for interest rates this summer. Read more

When the Federal Open Market Committee meets on March 17-18, it will be able to drop the word “patient” from its statement without shocking the markets. After some confusion, the Fed’s intentions on the date of lift off now seem fairly priced, with Fed funds rate contracts showing a probability of more than 50 per cent that the first move will come in June. The behaviour of the dollar, and of core inflation, are likely to determine whether June or September is eventually chosen for lift off.

Once that is out of the way, the markets will turn their attention to a much harder question: how rapidly will rates rise after lift off? The market currently expects a much more gradual path than the median shown in the FOMC’s “dot” chart, but there is huge uncertainty about this question on the committee. As the graph above shows, the interest rate forecasts for individual members of the FOMC, which will be updated on Wednesday, have a very wide range.

According to Fed vice-chairman Stanley Fischer, the rationale for rate rises is that the Fed wants to embark on a process of “normalisation”, and he is adamant that today’s rates are “far from normal”. That, of course, raises the question: how should we define normal? On this, the leadership group on the FOMC is not offering much guidance, but a common way of answering the question among macro economists is to consult the Taylor rule. Read more

At the National People’s Congress in Beijing on Thursday, Premier Li set a target of about 7 per cent for GDP growth in 2015, and around 3 per cent for inflation. At present, both targets look hard to attain, especially on inflation. Economic reform remains paramount for the government, but China’s premier made clear that this could only succeed in the context of adequate growth. This will probably necessitate a progressive easing in fiscal, monetary and exchange rate policy – something that is already under way.

The Chinese renminbi’s exchange rate has weakened noticeably against the dollar in the past few weeks, raising concern that Beijing is joining the “currency wars” that are (allegedly) being waged by other major nations.

A big change in China’s exchange rate strategy would certainly be something to worry about. Not only would it mean that the deflationary forces evident in the country’s manufacturing sector would be exported to the rest of the world, it would also disrupt the uneasy truce on trade and exchange rate policy that has emerged between the US and China since mid-2014.

Fortunately, on the evidence available to date, it seems that China has changed its currency strategy in a relatively limited way, and in a manner that is difficult to criticise in view of exchange rate turbulence elsewhere in the world. Read more

When Federal Reserve chairwoman Janet Yellen gives evidence to the Senate Banking Committee on Tuesday, she has an opportunity to speak above the heads of the financial markets to Congress and the American people. There is pressure in the Senate to bring the Fed under Congressional “audit”, something that almost everyone in the central bank abhors. So Ms Yellen’s main message is likely to be about how well the Fed has done in recent years, focusing on the generally good out-turns for unemployment and inflation. Read more

The giant Euro symbol stands illuminated outside the headquarters of the European Central Bank (ECB) on November 5, 2012 in Frankfurt, Germany (Photo by Hannelore Foerster/Getty Images)

  © Hannelore Foerster/Getty Images

The markets are waking up to the fact that the euro area faces a critical few weeks in which its economic path for 2015, and maybe for much longer, will be largely determined. Three inextricably linked events will dominate the economic landscape in January: the preliminary opinion of the Advocate General of the European Court of Justice (ECJ) on the legality of central bank bond purchases, due on January 14; the decision of the European Central Bank’s governing council on the size and type of “sovereign” quantitative easing (QE), due on January 22; and the Greek election on January 25.

At the optimistic end of the spectrum, the euro area might emerge with a more complete monetary framework that for the first time enables it to pursue monetary policy effectively at the zero lower bound for interest rates, and with the sanctity of the currency area reinforced. At the pessimistic end, the ECB could become shackled with an ineffective version of QE just when the euro area is officially entering outright deflation, and the single currency itself might become incompatible with political realities in Greece.

The outcome will also have much wider global implications. The markets have remained relatively relaxed about the likely exit of the Federal Reserve from its own zero interest rate policy in 2015, but only because the ECB and Bank of Japan are injecting more monetary stimulus. If large scale ECB action is removed from this equation, sentiment on global risk assets may darken considerably. Read more

The FT’s Martin Wolf has said almost everything that needs to be said about the global economic effects of the 2014 oil shock, but one additional point is worth emphasising. This is the fact that the US Federal Reserve and the European Central Bank view the consequences of the oil shock entirely differently. The markets have, of course, already been acting on this assumption, but the extent of the gulf between the world’s two leading central banks on this issue has been underlined by Mario Draghi’s dovish speech last month, and particularly by the Fed vice-chairman Stanley Fischer in a somewhat hawkish interview with The Wall Street Journal.

In perhaps his most significant statement since becoming vice-chairman in May, Mr Fischer made it clear that the period of low inflation due to falling oil prices will not deter the Fed from starting to raise interest rates next year. Furthermore, he suggested that the Fed might soon drop the assurance that it would not raise rates for a “considerable time”, replacing it with alternative language that is less constraining on its future actions.

It now seems likely that this language change could happen at the next Federal Open Market Committee meeting on December 16 and 17. By contrast, Mr Draghi and his supporters at the ECB clearly view the oil shock as a reason to shift policy in a more expansionary direction – if not at Thursday’s policy meeting, then sometime fairly soon. Read more

The simmering row between the European Central Bank president Mario Draghi and the German Bundesbank president Jens Weidmann is sometimes painted in personal terms, but in fact it epitomises a wider difference between the hawks and the doves on the ECB governing council. It is important to understand the anatomy of this dispute as the central bank prepares for its next critical meeting on December 4.

The dispute is fundamental and longstanding. Mr Draghi has adopted the New Keynesian approach that dominates US academia and central banking. There is really no difference between the philosophy that underpins his latest speech and that of Ben Bernanke, vintage 2011-13. In contrast, recent remarks by representative hawks such as Mr Weidmann and ECB executive board member Yves Mersch stem directly from the Austrian school of European economics. It is no wonder that these differences are so difficult to bridge. Read more

The examination is over. For more than a year the European Central Bank has been shining a light on the books of the eurozone’s banks; this weekend it reported its conclusions.

The balance sheets of 25 institutions were found wanting; the ECB concluded that they need an extra €25bn between them to be able to withstand a nasty economic surprise. Two crucial questions remain. Has enough at last been done to fix the European banking system? And will this on its own be enough to ward off the threat of deflation that is hanging over the eurozone? Read more

Mario Draghi (DANIEL ROLAND/AFP/Getty Images)

  © Daniel Roland/AFP/Getty

Mario Draghi’s remarkable speech at Jackson Hole has raised expectations that ECB purchases of sovereign debt will be soon announced by the governing council, if not this Thursday, then perhaps by the end of the year. In all the excitement about QE, the importance of Mr Draghi’s remarks about fiscal policy have gained less attention in the markets.

Mr Draghi’s speech broke new ground for an ECB president, and this could herald a significant change in the stance of fiscal policy in the entire euro area. Unusually, fiscal policy could be as interesting for markets as monetary policy in the months ahead.

Traditionally, ECB presidents have always argued in favour of fiscal austerity, and have of course refused to countenance any form of monetisation of budget deficits. The stance on monetisation changed a few months ago, and now even the Bundesbank accepts that QE is within the terms of the treaties.

But the Germanic approach to the fiscal stance (ie the level of budget deficits, as opposed to how they are financed), is only now being seriously questioned by the ECB for the first time. Not surprisingly, this is reported to have triggered consternation in Germany, and approval in France.

Mr Draghi’s new views on fiscal policy stem from a change in his underlying analysis of the economic problem facing the euro area. This has led the ECB president to throw his weight behind a fiscal plan which is slowly emerging from the European Commission, in conjunction with France and Italy. Now that the ECB has gone public on this, the pressure on Germany to give ground has increased markedly. The debate on this subject within Germany itself is clearly becoming crucial. Read more

“Pent up wage deflation” is an unfamiliar and somewhat abstruse term dropped into the economic lexicon last week by Janet Yellen at the annual Jackson Hole conference. Originally coined by researchers at the Federal Reserve Bank of San Francisco, the term is destined to be widely discussed because it is clearly influencing the US Federal Reserve chair’s thinking. If it exists, it would explain why wage inflation seems abnormally low, given the recent rapid drop in unemployment, and that could eliminate one important reason for keeping US interest rates at zero per cent for the “considerable period” promised by the central bank.

Ms Yellen is right to be aware of the concept, and to keep it under review, but in my view the Fed is unlikely to shift in a hawkish direction solely because of it. This blog explains the theoretical and empirical reason why this is the case.

(Warning some of these arguments are quite intricate – skip to the end if you want to avoid the economic debate and just want the policy implication.) Read more

There has been a significant weakening in China’s exchange rate in recent days. Although the spot rate against the dollar has moved by only about 1.3 per cent, this is actually a large move by the standards of this managed exchange rate. Furthermore, the move is in the opposite direction to the strengthening trend seen in the exchange rate over the past three years.

This has triggered some pain among investors holding long renminbi “carry” trades, along with much debate in the foreign exchange market about what the Chinese authorities are planning to do next. Since China does not explain its internal or external monetary policy in a transparent manner that is intelligible to outsiders, there is much scope for misunderstanding its true intentions. The key question is whether the Chinese authorities are changing their commitment to a strong exchange rate and, if so, why? Read more

The leading central banks in the developed economies have, of course, been the main actors underpinning the global bull market in risk assets since 2009. For long periods their stance has been unequivocally dovish as they have deliberately tried to strengthen an anaemic global economic recovery by boosting asset prices.

In the past week, we have had major statements of intent from Janet Yellen, the new US Federal Reserve chairwoman; from the European Central Bank; and from the Bank of England. After multiple hours of fuzzy guidance about forward guidance, the clarity of previous years about the global policy stance has become much more murky. Central banks are no longer as obviously friendly to risk assets as they once were – but they have not become outright enemies, and they are unlikely to do so while they are concerned that price and wage inflation will remain too low for a protracted period.

It is now quite difficult to generalise about what central bankers think. However, a few of the necessary pieces of the jigsaw puzzle slotted into place in the past week. Read more

Ben Bernanke’s tenure as Federal Reserve chairman ends this week. Financial Times markets and investment columnist John Authers speaks to Gavyn Davies, principal of Fulcrum Asset Management, who analyses the massive expansion of the Fed’s balance sheet under Mr Bernanke, and the course he has set for his successor, Janet Yellen

The generally optimistic tone at Davos last week was rudely interrupted by a melt-down in emerging markets, triggered by concerns that the major central banks in the developed economies are contemplating an exit from easy money sooner than previously expected.

The Fed will probably take its second step towards tapering next Wednesday and now seems to be on auto-pilot for the rest of the year. More surprisingly, the Bank of Japan sounded some cautious notes about the likelihood of further quantitative easing when fiscal policy tightens in April. Finally, the UK authorities, in the shape of “aides of the Chancellor”, hinted that a rise in short rates may be no bad thing this year.

A significant shift towards tighter monetary policy in the developed world as a whole still seems extremely unlikely, given the deflation risks highlighted by the IMF last week.

But the British case is now very intriguing and, after contradictory messages at Davos, also somewhat confused.

Because of low productivity, the level of UK GDP continues to lag well behind the recovery from the Great Recession achieved in many other economies. But the remarkable recent surge in UK growth rates, along with a sharp fall in unemployment, means that the Bank of England now has to reconsider its entire monetary stance. With forward guidance now in murky waters, the markets will want greater clarity in the next Inflation Report in February. Read more