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 long farewell to quantitative easing, one of the most remarkable experiments in the history of macroeconomic policy, starts now. In the wake of the strong US employment data in recent months, the Federal Reserve finally announced that it will taper its asset purchases from January onwards. The Fed’s balance sheet will stabilise in 2014, but will not begin to decline for several more years.
Variously described as the saviour of the global economy, totally irrelevant, a drug for the financial system or the harbinger of future inflation, QE is still controversial and insufficiently understood. Macro-economists are destined to be studying its effects for decades to come. Here are some early reflections. Read more
Janet Yellen has been nominated to take over as Fed chairman when Ben Bernanke steps down. Gavyn discusses with John Authers what a Fed led by Ms Yellen would mean for tapering and interest rate policy
The financial markets, after many months of forward guidance and supposedly “transparent” communication from the Fed, were very surprised by the FOMC’s latest decision to delay the start of tapering its asset purchases. This can be seen most clearly in the immediate 0.15 per cent drop in the yield on ten year treasuries, which reflects the extent of the lurch towards dovishness shown by the committee.
Prior to the announcements, the market thought that it knew two things with a high degree of confidence. First, the Fed chairman had said explicitly that the start of tapering was likely “in the next few meetings” and then clarified that this meant “before the end of the year”. Second, he had given explicit guidance that the end of tapering would occur around the middle of 2014, by which time the unemployment rate was expected to be below 7.0 per cent.
Given that the starting and ending dates for tapering were well pinned down, only the pace in between seemed to be up for debate. This left little room for manoeuvre on the final total for the Fed balance sheet, which was thought to be around $4.1 trillion (or 24 per cent of GDP).
All of this has now been thrown into considerable uncertainty following the chairman’s latest press conference. It is no longer as likely that the start of tapering will come this year, though December now seems to be the best single bet. Not can it be assumed that the 7 per cent unemployment rate is a good guide about the end point. Although the FOMC’s economic projections still show unemployment dropping below this rate somewhere around mid-2014, the chairman seemed to pour cold water on the importance of the 7 per cent figure, a consideration he himself had voluntarily introduced in the June press conference. Read more
The US official statisticians have today issued revised statistics for GDP dating all the way back to 1929. It may be alarming for investors and policy makers to hear that our understanding of economic “truth” needs to be amended for the last 84 years, but the changes have not in fact made much fundamental difference to the debates which matter for the economy today.
In particular, there has been very little change in the Fed’s likely view of the amount of slack which remains in the economy, though the latest version of growth in the last few quarters, including the publication of data for 2013 Q2 for the first time, may persuade them that economic momentum is a little firmer than previously believed.
The most dramatic-sounding news in today’s release is that the level of nominal GDP has been revised up by 3.4 per cent in 2013 Q4. This follows a number of methodological changes, the most important of which is to treat R&D spending as a positive contributor to investment and GDP, rather than as an input to the production process. But since this change impacts GDP levels for decades in the past, it does not make much difference to our understanding of the economy’s capacity to grow in the immediate future. It simply involves viewing the same objective truth through a different coloured lens. For most practical purposes, this change can be ignored.
There are, however, three areas where the revisions could be significant: Read more
When we look back on the FOMC meeting on June 19 2013, it will probably be seen as the moment when the Fed signalled that it was beginning the long and gradual exit from its programme of unconventional monetary easing. The reason for this was clear in the committee’s statement, which said that the downside risks to economic activity had diminished since last autumn, presumably because the US economy had navigated the fiscal tightening better than expected and the risks surrounding the euro had abated.
This was the smoking gun in the statement. With downside risks declining, the need for an emergency programme of monetary easing was no longer so compelling. The Fed has been the unequivocal friend of the markets for much of the time since 2009, and certainly ever since last September. That comfortable assumption no longer applies.
Fed chairman Ben Bernanke, however, went to great lengths to mitigate the hawkish overtones of this message in several respects. The asset purchase programme would be ended only when the US unemployment rate has fallen to 7 per cent, which the central bank expects to happen by mid-2014, he said. In the meantime, the pace of asset purchases could be increased as well as reduced, depending on the incoming economic data. Read more
The month just ended was the fourth worst month for government bond returns in the past two decades. This abrupt response to Ben Bernanke’s warning that the Fed might think about tapering QE at some point in the next few meetings has naturally raised fears that the great bull market in fixed income, which started in 1982, might now be threatened by a sharp reversal.
Some analysts regard this as the inevitable bursting of a bubble which has been created by the actions of the central banks (see this earlier blog). Others, like Jim O’Neill, regard the rise in bond yields as the start of a return to economic normality, and argue that would be a very good thing as long as it occurs in an environment of recovering economic confidence. Paul Krugman also points out that the pattern of behaviour in the major markets – bonds down, dollar up and equities up – is consistent with greater optimism about the US economy, rather than worries about the Fed or the onset of a debt crisis. Read more
The volatility in financial markets since Mr Bernanke gave evidence to Congress yesterday is a not-so-gentle reminder of what might happen when the Fed eventually begins to withdraw monetary accommodation. The Chairman’s warning that the FOMC might reduce the pace of its asset purchases “in the next few meetings” has clearly spooked the markets, especially those (like Japanese equities) where bullish positions had become very crowded.
The Fed’s main message at present is that it will “increase or reduce the pace of its asset purchases…as the outlook for the labor market or inflation changes”. This seems deliberately designed to inject some uncertainty into market psychology, and thereby prevent an excessive risk taking. Mr Bernanke said that he takes the risk to financial stability “very seriously”.
But the overall tone of the Chairman’s written evidence yesterday strongly suggested that the Fed is still a long way from contemplating any significant change in monetary policy. After all, tapering QE would only imply that the pace at which policy is being eased is being reduced. An outright tightening of policy still seems to be several years away. Read more
The package of quantitative easing announced today by the new regime at the Bank of Japan is one of the largest monetary injections ever announced by the central bank of a major developed economy. The only rival for that crown is the emergency easing in monetary policy which took place in most economies in late 2008. But today’s BoJ action has not been driven by any short-term emergency. It represents a deliberate change in philosophy, and a complete abandonment of everything that the Bank of Japan has said about monetary policy in the past two decades. Those who believe in quantitative easing certainly have their experiment, writ large in Tokyo.
In effect the new governor, Haruhiko Kuroda, has imported into Japan the whole of the Federal Reserve’s post-Lehman balance sheet strategy, and he will implement it in under two years, instead of the five years or more taken by the Fed. The doubling in the Japanese monetary base over a period of 21 months is in itself remarkable. Taken together with the extension of the duration of bonds purchased from less than 3 years to an average of 7 years, the injection becomes of historic proportions.
The new strategy brings, for the first time, a real prospect of breaking the deflationary psyche which has plagued Japan for so long. But it also brings risks that the strategy might work too well, with inflation expectations unhinging the bond market. Mr Kuroda is trying to pull off a difficult trick, which is “to drastically change the expectations of markets and economic entities”, and to do so in a very particular way. Read more
The FOMC will meet on Wednesday with the markets feeling confident that there will be no change in monetary policy. This means that the $85bn per month rate of balance sheet expansion will probably remain in place. But recently chairman Ben Bernanke has conceded, rather reluctantly, that the Fed’s exit strategy from quantitative easing will soon need to be reconsidered by the committee, and the debate could start at this month’s meeting. In any event, with economists now upgrading their forecasts for US GDP for the first time in quite a while, the markets are increasingly focused on whether the exit can be handled successfully.
The first question is whether the exit will be gradual or abrupt. The chairman’s personal preference is very well known: it should be gradual, and extremely well flagged in advance. But Mr Bernanke might not be in office after next January, and there are others on the FOMC who could have different ideas. Furthermore, economic and market circumstances could change. In 1994, GDP growth and inflation both rose markedly, and the Fed slammed on the brakes without any warning. The resulting 3 per cent rise in the Fed funds rate delivered a major shock to the financial system. Read more
Professor Jeremy Stein is a much respected financial economist from Harvard who in May became a member of the board of governors at the Federal Reserve. Until last week, the markets had paid him relatively little attention, but that is now destined to change. The important speech he delivered in St Louis on Thursday about credit bubbles differed significantly from one of the main planks in the Bernanke/Greenspan doctrine of the past 15 years. It does not have immediate policy implications, but it could easily do so within two years.
The speech, which is nicely summarised here by Matthew Klein at The Economist, deserves to be read in full by all market participants. (One member of the FOMC told me last week that the speech was “geeky”, but that was intended, and taken, as a high compliment!)
In summary, the speech argues that the credit markets have recently been “reaching for yield”, much as they did prior to the financial crash. Although not yet as dangerous as in the period from 2004-2007, this behaviour is shown by the rapid expansion of the junk bond market, flows into high-yield mutual funds and real estate investment trusts and the duration of bond portfolios held by banks.
Governor Stein suggests (hypothetically) that this may become a policy headache within 18 months and, in a break with the Bernanke/Greenspan doctrine, he indicates that the right weapon to deal with this might well be to raise interest rates, rather than relying solely on regulatory and other prudential policy to control the process. This would obviously come as a big surprise to the markets, which have tended to view the Fed’s stated concerns about the “costs of QE” as so much hot air. Read more
Professor Michael Woodford of Columbia University is an extremely renowned macro-economist, and rightly so, but only recently has he occupied a central place in market thinking. Since his paper on US monetary policy at Jackson Hole, and the favourable remarks which Ben Bernanke made about him, everyone is trying to understand what his influence on the Fed might eventually mean.
His writing can be complex and intricate, which is in the nature of the subject, but his current policy recommendation is quite clear: the Fed should adopt a target for the level of nominal GDP which would have the effect of increasing price inflation, and inflation expectations in the period ahead, and thus reduce the real rate of interest.
If the controlling majority which surrounds the chairman on the FOMC has fundamentally accepted the thinking which backs these recommendations, as many investors believe, then there has been a profound change in Fed strategy. However, I am not convinced that this is the case. Mr Bernanke has not yet crossed the inflation Rubicon. Read more
Ben Bernanke has boldly gone where no Fed chairman has gone before him with his third round of quantitative easing. Gavyn Davies discusses with the FT’s Long View columnist John Authers why Mr Bernanke has chosen this path – and its risks:
Ben Bernanke. Image by Getty.
Ben Bernanke, Fed chairman, will speak about “Monetary Policy Since the Crisis” at the Jackson Hole Symposium at 10 am (EDT) on Friday. The markets have learned to focus intently on such occasions, since there is something in the clean air of Wyoming which seems to inspire Mr Bernanke. On several occasions in recent years, the tone he has adopted at Jackson Hole has set the trend in financial markets for many months to come.
This year, there are doubts about what the chairman might say. The markets have already assumed that a further monetary easing by the Fed is just around the corner, almost certainly to be announced at the next FOMC meeting on September 12-13. At the very least, this will probably involve an extension of the Fed’s guidance on “exceptionally low” levels for the federal funds rate from the end of 2014 at least to mid 2015.
However, there is uncertainty in the markets about whether the FOMC is minded to do anything more aggressive than that in September. That possibility was raised by the dovish set of minutes for the 31 July/1 August FOMC meeting which were published last week. The key question is whether Mr Bernanke will choose to clarify the ambiguities in these minutes in either direction. Read more
The fall in US unemployment remains slow but with no clear deflationary threat the US Federal Reserve is in a quandary regarding the next steps in its monetary policy. John Authers, Long View columnist, asks Gavyn Davies, chairman of Fulcrum Asset Management, what Ben Bernanke, chairman of the Fed, is most likely to do next.
Risk assets rose slightly last week, and global equities are still trading within about 2 per cent of their highs for the year. The resilience of equities was slightly surprising in a week which saw both a disappointing set of US GDP data and a Fed policy statement which was on the hawkish side of expectations. Goldman Sachs’ economists commented that the US economy and financial markets are “moving into a tougher environment”, in which the economy is slowing and the Fed is shifting its policy reaction function in a less stimulative direction.
One reason why risk assets have remained firm recently, is that earnings in the latest company reporting season have once again been beating expectations in the US and the eurozone. According to Jan Loeys at JP Morgan, US corporate earnings per share for 2012 Q1 have come in 8 per cent higher than analysts’ expectations, while the drop in eurozone earnings has been 4 per cent less than feared. Clearly, corporate financial strength has been helping investment sentiment, but that would not persist for very long if the Fed really did change its tune on monetary policy. Read more
Ben Bernanke has been very focused on the Fed’s “communications strategy” for several years now, and has patiently pushed the FOMC in his desired direction during a series of detailed discussions. Now it seems that he has reached his destination, and will reveal all (or almost all) in his press conference after the FOMC meeting which begins on Tuesday. Always a fan of explicit inflation targets, the chairman seems finally to have won agreement from colleagues on establishing a formal objective for core inflation of about 2 per cent, though the FOMC will also need to keep Congress happy by talking about its long term unemployment objectives as well. More unconventionally, each member of the FOMC will also publish for the first time their projections for the Fed funds rate extending to 2016.
What is the motivation behind these changes? Mr Bernanke has normally justified such steps in terms of stabilising expectations about the Fed’s genuine intentions, especially on inflation and the forward path for interest rates. At a time when the extension of the balance sheet is causing political difficulties for the Fed, and when inflation expectations could become unhinged by the rapid expansion of the monetary base, the chairman is looking for alternative ways of easing monetary conditions without printing more money. Modern macro-economics suggests that operating on expectations is one of the most powerful tools available to him, though he is using it much more cautiously than many economists would like to see. Read more
The key focus of the coming week in financial markets will be the speech of Fed chairman Ben Bernanke at the Jackson Hole conference on Friday. Last year, the same speech was taken as confirmation that the Fed intended to embark on QE2, and this eventually triggered a 30 per cent rise in risk assets over the next six months. With the economy still weakening, the Fed is once again in easing mode, and some in the markets are hoping for another full dose of QE. They are likely to get something rather different. Read more
Opinion is sharply divided about what the Fed intended to signal in the statement issued on Tuesday. Some have seen the statement as very dovish, because it said that the Fed intended to leave short rates at “exceptionally low levels” until mid 2013 – the first time that a specific date of this sort has ever been set by the FOMC.
Others, however, concluded that the statement contained nothing really new, since the markets had already assumed that short rates would be close to zero for the next two years. Furthermore, the fact that there were three dissents from the majority decision has led some to deduce that the further large step to more quantitative easing (QE3) is still a long way off. On this view, nothing really changed. Read more
Ben Bernanke. Image by EPA.
The financial markets seem determined to interpret today’s statement by the Fed chairman in a dovish light, but a careful reading of his words does not support that point of view. True, Mr Bernanke outlined the possible ways in which monetary policy might be eased further if recent economic weakness should prove more persistent than expected. But he gave equal weight to the possibility that “the economy could evolve in a way that would warrant less-accommodative policy”.
There was no hint in the text about which of these outcomes he considered the more likely. We already knew from yesterday’s FOMC minutes for the June meeting that the committee is split about the likely evolution of policy, and we were waiting to see today whether the chairman would throw his weight behind either the doves or the hawks. He failed to do either. Read more