The equilibrium real interest rate continues to lie at the heart of discussions about economic policy in the US and elsewhere. Ben Bernanke has written that the equilibrium rate, and not the FOMC, is the ultimate determinant of interest rates in the economy, and claims that it is discussed at every Fed meeting. The recent debate about secular stagnation between Mr Bernanke and Lawrence Summers centres on a difference about the future path for the equilibrium rate. And Cleveland Fed President Loretta Mester says that it is “the issue policy makers are grappling with” at the FOMC.

Most important of all, Janet Yellen has focused all her intellectual firepower on the subject in her most important speech on monetary policy since she became Fed Chair. In this recent blog, I outlined the meaning of the equilibrium rate, and showed that the FOMC’s implicit forecast for that rate accounts for much more than half of the tightening in US rates indicated in the committee’s dots chart over the next 3 years.

The markets, however, do not believe the dots, and forward rates show a much smaller increase in US rates than the Fed indicates. The future path for bond and equity prices will depend largely on who is right about the equilibrium real rate: the Fed or the markets? Read more

Last month, the global report card concluded that world economic activity was expanding at a roughly constant growth rate, with a slowdown in the US and China being offset by faster growth in the eurozone and Japan.

In March, these broad trends continued, but the decline in the US growth rate became more pronounced, while Japan also slowed sharply. Chinese activity growth has been stable this month. Overall, the global growth proxy that we use for “flash” monthly estimates (ie the advanced economies plus China) dropped a little in March, causing some concern that the downward momentum in the US may be beginning to dominate the picture.

However, there is much brighter news from the eurozone, where the peripheral economies (notably Spain and, now, Italy, are reporting much firmer growth rates. Furthermore, the UK is still doing very well, and Sweden is accelerating markedly. France is an important exception to this general rule of improving European growth trends.

We will be watching global activity indicators very carefully at the start of the second quarter to determine whether a further and more worrying slide in growth momentum is taking hold. At present, we do not expect this to happen, but we now have somewhat greater concern about the status of the global economic cycle. Read more

Yellen Discusses Monetary Policy At Federal Reserve Bank In San Francisco

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The financial markets listened to Janet Yellen’s speech on “normalising” monetary policy last Friday, shrugged, and moved on largely unaffected. It was, indeed, a dovish speech, of the type that had been foreshadowed at her press conference after the FOMC meeting in March (see Tim Duy for a full analysis). But it also spelled out her analytical approach to monetary policy more clearly than at any time since she has assumed the leadership of the Federal Reserve.

In the speech, the Fed chairwoman used the term “equilibrium real interest rates” no less than 25 times. This concept is very much in vogue at the Fed. The Yellen speech uses it to explain what she and Stanley Fischer mean by “normalising” interest rates. It was also at the centre of Ben Bernanke’s first forays into economic blog writing this week, which reminds us that it has some pedigree at the central bank.

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Yellen Discusses Monetary Policy At Federal Reserve Bank In San Francisco

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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

The Federal Reserve Begins Last Meeting Of 2008

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When the Brazilian finance minister Guido Mantega complained that the Federal Reserve was waging a currency war against his country in September 2010, his comments led to a wave of sympathy and concern. The Fed’s aggressive monetary easing was causing a capital flight from the US into the apparently unstoppable emerging markets.

Uncompetitive exchange rates and domestic credit booms in the EMs were the result of US quantitative easing. American monetary policy makers showed little sympathy, arguing that the US had its own domestic inflation and unemployment mandates to worry about. If the dollar fell in the process, so be it.

That episode proved short lived. The Brazilian real is now a chronically weak currency. Yet the term “currency wars” has stuck. It is now alleged that almost all the major central banks are engaged in weakening their currencies, if not against each other then certainly relative to commodities, goods and services. 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


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In last month’s global growth report card, this blog reported that the growth in economic activity in the major economies was fairly steady at an above trend pace, though the US and China were slowing, while other major economies were accelerating. A similar pattern has emerged from the latest data.

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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

February was another very strong month for global equities, with the US market enjoying its best month since October 2011. Global equities are now up by 5.1 per cent this year, exceeding even the heady pace of the 2012-14 advance, though this time the Eurozone (+ 14.7 per cent) has outpaced the US (+ 2.2 per cent).

Once again, the pessimists have been confounded. The US market has now tripled since 2009, and has risen in a virtually straight line for over three years. The analyst community on Wall Street remains almost uniformly bullish about US stock returns in 2015. Although cynics will say “they always are bullish, that is what they are paid for”, many other indicators point to extremely positive market sentiment, with active equity investors generally positioned for further upside. And the VIX measure of equity volatility, a gauge of investor concern, is languishing near its long term lows at about 13.

Has the US market finally reached the point of over-exuberance? As Warren Buffet reminds us this weekend, market timing is always difficult, and it is particularly difficult to pick the top of a rampant bull market. But there are certainly increasing grounds to worry about the sustainability of the market’s advance in the rest of this year. 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

When the Federal Reserve starts to raise US interest rates later this year, there will be a major shift in the global monetary regime. Although San Francisco Fed President John Williams has tried to deny that this will represent a tightening in monetary conditions in America, his claim strains credulity beyond breaking point. US monetary conditions may remain easy in absolute terms but, after lift off, the direction of change will unequivocally be towards tightening.

Should investors be worried about what is likely to be only a very gradual change in Fed policy? The taper tantrum in 2013, and the flash crash in bond yields last October, were both unwelcome signals that frothy markets can over-react to very modest changes in economic fundamentals. Read more

Oil prices have rebounded by $16 a barrel since the low point was reached at $45 a month ago, and investors are already wondering whether the worst is over for the energy sector. The bear market that started in 2011 has seen a peak-to-trough decline in overall commodity prices of 46 per cent, which is almost exactly the same decline experienced in the six previous bear markets, though this one has lasted 3.7 years, compared to an average of 2.3 years (according to JPMorgan). Based on the past chronology of commodity bears, the trough is now overdue.

It will of course be impossible to pick the local bottom with any precision. Last year’s collapse in oil prices was not built into the forward markets. Nor was it predicted, even as an outside possibility, by economists and oil analysts. Few macro investors made any significant money from it, until trend-following funds entered significant short positions towards the end of the year.

The inability of economists to forecast such an important event, not just for commodity markets but for bonds and equities as well, is certainly sobering. But almost without pausing for breath, we are faced with another urgent and unavoidable question: does the bounce in oil prices in the past month herald the end of the crash? Read more

This blog presents the first in a regular series of monthly report cards on the state of global economic activity. The real time activity growth rates are derived from the latest Fulcrum “nowcasts”, based on dynamic factor models. These nowcasts, estimated by Juan Antolin Diaz and colleagues, combine a very large number of different statistical releases to identify a single growth “factor” that is assumed to be driving the economies in question.

The Fulcrum models build on the pioneering work of Lucrezia Reichlin, Domenico Giannone and others at the ECB and LBS. (Professor Reichlin’s subscription service is available here.)

As a San Francisco Fed study pointed out last week, GDP forecasts for the year ahead are not only “persistently optimistic”, but they are typically very significantly affected by the actual GDP data for the most recent quarter. Financial markets are therefore sensitive to quite small swings in activity data. It is important for investors to track the data flow, much of which is confused and contradictory, in the most efficient manner possible. We believe that factor models are helpful in doing this.

Last week, the markets shifted slightly away from pessimism about global growth, with bond yields, commodity prices and US equities all rising for the first time in quite a while. This is in line with the recent information flow, which seems to be be moderately encouraging.

A pick-up in activity in both the Eurozone and Japan is countering, and perhaps more than offsetting, a slowdown in the US. Global retail sales volume is rising strongly as oil price effects feed into consumer confidence, and manufacturing sectors seem to have eliminated the excess inventories that accumulated late last year. In the advanced economies, growth is now running at a significantly above the trend rates derived from the models. But in China, the progressive and gradual slowdown continues.

We show the recent history of results from these models, updated daily, in the graphs below. In future, this blog will update these results soon after the global PMI surveys and the US jobs data are published in the first week of each month. Read more

As global bond yields plumb new depths, an unprecedented experiment in monetary policy is underway in two small countries in Europe. By pushing policy interest rates more deeply into negative territory than ever seen before, the Swiss and Danish central banks are testing where the effective lower bound on interest rates really lies. The results are being closely watched by bond investors, and by the major central banks, which had previously assumed that the effective lower bound was close to zero.

The Danish central bank cut interest rates to -0.5 per cent last week, the third cut in the last two weeks. The Swiss National Bank cut its deposit rate to -0.75 per cent when it recently removed the ceiling on the Swiss franc.

Money market rates in Switzerland have fallen to a low of -0.96 per cent. Bond yields have followed suit, right across the curve (see graph). Those who believed that long bond yields could not go negative have had a rude awakening.

Denmark and Switzerland are clearly both special cases, because they have been subject to enormous upward pressure on their exchange rates. However, if they prove that central banks can force short term interest rates deep into negative territory, this would challenge the almost universal belief among economists that interest rates are subject to a zero lower bound (ZLB). Read more

The Federal Open Market Committee of the Federal Reserve (FOMC) will meet on Wednesday amid signs that the broad consensus among economists in favour of an interest rate increase around mid year is beginning to crumble. So far, there is no public indication that Ms Yellen and her key supporters are changing their minds, but many leading economists outside the Fed, from across the spectrum of economic thought, are now vehemently opposed to the Fed’s plan. It would not be surprising if the Yellen camp were reviewing their intended date for lift off, though we are not likely to see much evidence of this at the January FOMC meeting.

Since the last FOMC meeting in December, when Ms Yellen gave a very clear signal in favour of a June lift off, the market has moved sharply in a more dovish direction. Bond yields have continued to plummet, with break-even inflation expectations falling markedly. Furthermore, the front end of the bond market is now ignoring the FOMC’s projections for rates almost completely (see the “dots” chart on the right), in effect challenging Chair Yellen to tell them next week that they are wrong.

This is getting much more tricky for Ms Yellen. The smooth, fully anticipated, glide path towards a June lift off is now being seriously challenged, both in the markets, and among influential outside economists, who are directly accusing the Fed of complacency (here and here). But there is still some time left before the final decision has to be made. The Fed Chair will probably want to retain her option to move in June in next week’s FOMC statement but, on the other hand, is unlikely want to deliver a major hawkish shock to market opinion at this stage. This week’s meeting will be a holding operation. Read more

Mario Draghi

  © Hannelore Foerster/Getty Images

And then there were none. On Thursday, the European Central Bank became the last of the major central banks to announce a large programme of quantitative easing, involving the purchase of over €1tn of assets, mostly eurozone government bonds, in the next 18 months.

Is this the “credible regime change” which economists like Paul Krugman say is the only way that central banks can affect growth and inflation when interest rates have reached the zero lower bound? It would be too optimistic to say “yes”, but it is certainly a major philosophical shift by the conservative standards of the ECB. Originally designed slavishly on the Bundesbank model, the ECB has declared independence from its German forebears today.

But the long delays in reaching this point have made the eurozone deflation threat more severe than it need have been. Whether this belated recognition of reality is a case of better late than never, or too little too late, remains to be seen.

The markets are likely to assess the package with three litmus tests: is it big enough, are the restrictions placed on the bond purchases too restrictive, and does it matter that the decisions were far from unanimous, with the Bundesbank probably opposed to some key elements? In my view, the good clearly outweighs the bad. Read more

The completely unexpected decision of the Swiss National Bank (SNB) to remove the 1.20 floor on the Swiss franc against the euro on Thursday was one of the biggest currency shocks since the collapse of the Bretton Woods system in 1971. The decision has been heavily criticised, both for its tactical handling of the foreign exchange market, and for the collapse of the centrepiece of its monetary strategy, without (apparently) any overriding cause. The credibility of a central bank that has traditionally been hugely respected by the markets has clearly been dented.

The decision has already caused severe stress and bankruptcies in the currency market, and it is far too early to judge whether this has now settled down. More importantly, the deflationary shock to the Swiss economy will be severe. And there are concerns that the failure of the SNB’s policy of unlimited market intervention may have much more profound implications for the credibility of the wider market interventions by global central banks, on which asset prices currently depend.

It is important to keep this in perspective. The SNB decision may have been driven to a large degree by the fear of losses on the central bank’s balance sheet, which are peculiar to the ownership structure of the central bank in Switzerland. Furthermore, other major central banks are not operating currency pegs, where large balance sheet losses tend to occur. Even so, this event will clearly make investors question whether the central banks can indefinitely exert as much control over the financial markets as the period of quantitative easing has suggested. Read more

he oil price has fallen by more than half in a little over six months, and you might expect investors to be cheering. Perhaps they would have been — had the result not been a precipitous drop in inflation.

A flight to the safety of government bonds has caused yields to fall lower than they have been at any time other than the darkest days of the euro crises of 2012. Although stock markets are still only 3.5 per cent from their all time highs, they have become a lot choppier. Prices are bouncing up and down, suggesting investors have become more nervous about the prospects for economic growth. Read more

The Brent oil price has fallen by a further 9.3 per cent in the first few days of 2015, making the total decline since mid 2014 a remarkable 56 per cent. With Saudi Arabia showing very little sign of restricting supply, economists have been scrambling to reduce their global inflation forecasts in line with the new reality in the oil market.

For investors and central bankers, two questions are dominating discussion – how much deflation will be seen in 2015, and how severe a threat does it pose to the health of the global economy? The answers are complex, because deflation is occurring simultaneously in two different varieties.

The first is “good” deflation, stemming from the huge beneficial supply shock from oil. But the second is “bad” deflation, stemming from a persistent shortage of aggregate demand in the developed economies, especially the eurozone.

At present, good deflation is definitely dominating the global picture, and this is being priced into asset markets. But the threat from bad deflation in the eurozone is still rumbling away in the background. 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