The most newsy point from NY Fed president William Dudley’s speech today was his call for a change in exit strategy, urging the central bank to reinvest in its mortgage portfolio. But there was a lot more going on in the speech: Mr Dudley put a dovish spin on the Fed’s inflation target. He said bank regulation may be driving down neutral interest rates, and he put markets on notice that how they price bonds will decide how the Fed changes interest rates.
(1) Inflation is coming
Mr Dudley’s tone on inflation was different to the isn’t-it-worringly-low type of remarks that Fed officials have tended to make recently. Instead, he expects inflation to head upwards, and seemed to be testing arguments for why Fed policy should not react.
“With respect to the outlook for prices, I think that inflation will drift upwards over the next year, getting closer to the FOMC’s 2 percent objective for the personal consumption expenditure deflator . . . That said, I see little prospect of inflation climbing sharply over the next year or two. There still are considerable margins of excess capacity available in the economy—especially in the labor market—that should moderate price pressures.”
I’m pretty sure that the answer is ‘No’, at least for now. For background, the effective Fed Funds rate has been falling steadily for the last couple of months:
Manila has raised its key policy rates quarter of a point – as signalled – to combat rising prices and manage inflation expectations. The overnight borrowing rate now stands at 4.25 per cent and the overnight lending rate at 6.25 per cent. The interest rates on term repos, reverse repos, and special deposit accounts were also raised accordingly.
Inflation is running at the high end of the 3-5 per cent target range, and deputy governor Diwa Guinigundo said it would have averaged 5.2 per cent this year without today’s interest rate move. The central bank indicated further upward inflation pressure lay ahead, and that appropriate policy action would be taken. Analysts expect another one or two such rate rises this year, though some observed that domestic interest rate rises would have limited impact on imported global food and energy inflation.
India’s Bank rate, standing facilities and Liquidity Adjustment Facility – in short, the key tools the Bank uses to transmit its policy decisions to the real economy – are to be examined and compared with processes at major central banks by a special team at the RBI. Suggestions for changes are expected in three months’ time from the newly constituted Working Group on Operating Procedure of Monetary Policy, the Bank said.
The system of daily auctions, which absorb or inject liquidity – the Liquidity Adjustment Facility, or LAF – will come under particular scrutiny. Here there are no sacred cows: the group will examine the frequency and timing of auctions; the maturity period of the repos and reverse repos used to inject/absorb liquidity; and the size of the gap between the repo and reverse repo rates (the “corridor”). Indeed, the group should consider whether there should be a corridor at all. If so, it should consider whether its width be fixed or variable; and how to optimise its efficiency. Read more
Perhaps to offset rumours of further easing, the Fed has announced further trial runs of a key tightening tool.
The New York Fed will test one of its main liquidity-draining tools by conducting a “series of small-scale, real-value reverse repurchase transactions” with primary dealers et al. This repeats and expands upon a similar set of tests announced in October and run in December. Read more
The Fed is taking a Shakespearean attitude toward the exit: monetary tightening, a necessary end, will come when it will come.
But while the US central bank has made clear that the timing of the exit is still unknown, it’s taking steps to get ready for it when it comes. Read more
A new debate is set to rage within the Fed in the wake of its decision to re-open currency swap lines with foreign central banks.
Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, today said at an event in North Carolina that the move was “not a problem” but “we’re going to think about whether we sterilise” the swaps. Read more
The Federal Reserve today moved one – itty bitty – step closer to getting reverse repos ready to drain the system of excess reserves. Not that they’re in much of a hurry – monetary tightening still seems to be a long way off in the distance, but nice to be prepared. Read more
Snow could delay the hearing, but not the exit.
Today, after a six-week inclement weather delay, Ben Bernanke, chairman of the Federal Reserve, spoke before the House Financial Service Committee on how the central bank plans to become, once again, a standard central bank, unwinding itself from the emergency liquidity programmes it developed during the crisis and getting its balance sheet back to a more normal size. Mr Bernanke’s testimony was released when the committee was originally scheduled to meet in February.
So has the Fed developed further details in its exit strategy? Here’s what’s new from the hearing, as it happened. Read more
The FOMC today kept the federal fund rates unchanged and didn’t change its closely-watched “extended period” language.
Analysts had been waiting to see if more FOMC members would vote against keeping the extended period language, but the only vote against it was Thomas M. Hoenig, who had previously used his new voting powers to dissent during the January meeting. This month, he gave a reason for his dissent saying that “continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted because it could lead to the buildup of financial imbalances and increase risks to longer-run macroeconomic and financial stability.”
But, despite the Hoenig dissent, the meeting took the US no closer to policy normalisation. Read more