The Federal Reserve told us in December last year that it would maintain its asset purchases until the outlook for the US labour market had improved substantially. Does Tuesday’s rather anaemic jobs data release meet this criterion any more than it did last month, when the Fed decided not to taper its asset purchases? Not really.
The underlying pace of job gains is certainly not rising, and may even have fallen slightly. But the unemployment rate dropped to 7.2 per cent, and the pace of decline suggests that the 6.5 per cent threshold for considering interest rate rises could be reached in mid-2014, ie before the balance sheet tapering has ended! This gives Janet Yellen, the incoming Fed chairman, an early problem: she will surely have to reduce that 6.5 per cent threshold soon.
In this blog, we use some statistical tools which have been developed by the regional districts of the Fed to frame a judgment about the underlying state of the labour market, updated to include this week’s new information . 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
In the past decade, the world’s central banks – first in the emerging and then in the developed world – have embarked on a Great Expansion in their balance sheets which is unprecedented in modern times. This blog sketches the anatomy of the Great Expansion and attempts to project what will happen as the US Federal Reserve tapers its asset purchases in the next 18 months.
The latest episode in the saga has, of course, involved the Fed’s attempt to distinguish between “tapering” and “tightening”, a distinction which the markets have been reluctant to recognise . The US forward interest rate curve shows the first rate increase occurring very close to the time when the Fed is planning to stop buying assets in mid-2014. Whether it intended to do so or not, the Fed has de facto tightened US monetary policy conditions and will have to work hard to reverse this. 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 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
It is now almost universally accepted that the major central banks were woefully mistaken in ignoring the build up of credit risk in the years before 2008. Whether they should have acted through raising interest rates or by tightening regulations on the financial system is still under dispute, but the abject consequences of doing nothing are plain for all to see.
This has naturally made policymakers very determined not to make the same mistake again. But they are also aware that they do not want to be a group of generals focused on winning the last war. In the past, these decisions have not proved easy to make in real time. Consequently, a great deal of recent research has been aimed at doing better in future.
The Fed has been in the front line of this work, but the Bank for International Settlements has joined in with some very valuable insights and empirical work, led by Claudio Borio. Although there is clearly a very active exchange of views occurring at the Fed, the bottom line for investors is that restrictive monetary action in the US, in response to a build up of excessive financial risk, is not likely for quite some time. Read more
The markets were impacted yesterday by two very different sets of monetary policy minutes from the Fed and the Bank of England. In the case of the Fed, the worry is that the central bank is back-tracking on its commitment to maintain open-ended QE until the labour market has improved “substantially”. Meanwhile, at the Bank of England, the concern is that monetary policy might be too easy in the context of a declining exchange rate, and an inflation outlook that will exceed the official target for at least the next two years.
Although coming at the monetary policy problem from entirely different angles, these concerns have one thing in common. It has become increasingly difficult for both the Fed and the BoE to communicate their policy regime clearly to the markets in an environment where their policy committees have become openly split about the right stance to pursue in the months ahead. Read more
The growth rate of the global economy is experiencing its weakest patch since the “upswing” in the cycle began in 2009. Of course, it has never been much of an “upswing”, given the depth of the recession which followed the financial crisis at the end of 2008. Still, the big picture seemed to suggest that global GDP was slowly on the mend, if not at a pace which could reduce global unemployment very rapidly. Now, even that modest recovery seems to be at risk.
Yesterday, we saw another leg of the policy response to this renewed slowdown. Monetary easing from the ECB, the Bank of China and the Bank of England followed earlier action by the Federal Reserve. As noted in this earlier blog, the central banks are back in play.
Markets have not been oblivious to this renewed round of easing: since the end of May, global equities have risen by 8 per cent and commodity prices have recently rebounded from their lows in spectacular fashion. Although ”shock and awe” from the central banks seems to have been replaced by a sense of rather tiresome routine, the impact of QE on market psychology has not entirely lost its traction.
That will only last, however, if the current global slowdown proves to be just another mid-year lull in a generally recovering world economy. So what are we to make of recent data? Read more