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
Two of the least appealing features of central banks through the crisis have been their petty point scoring and over-complication of their operations. This creates the impression of big differences in approach, which I will explain is not true.
First, let me demonstrate what I am talking about with the use of a few examples. Spencer Dale, the Bank of England’s chief economist, crowed last week that “unlike some other central banks”, the Bank of England can “withdraw the stimulus, raising the bank rate and selling assets” without the “need to create new instruments to drain excess reserves or alter the terms of existing facilities”. But he was was not brave enough either to say that he was talking about the Fed, or to mention the complete failure of the Bank’s own sterling monetary framework during the crisis and its subsequent “alteration”.
But Spencer is far from alone. As Ralph has regularly pointed out, the ECB believes it spotted the crisis earlier than anyone else, thinks its liquidity operations were superior to those operated by the Fed and Bank of England before the crisis, and suggests it is ahead of the game on exit strategies.
The Fed, meanwhile, has got everyone excited about reverse repos and a whole raft of three and four-letter acronyms which serve, more often than not, to obscure its underlying policy rather than reveal it.
Rather than get irritated or confused by these traits, I would suggest that everyone remember the four following points about the banks’ plans to exit from their extremely loose policies:
1. They are all gradually eliminating their extraordinary liquidity policies
At its peak, the Fed was lending Read more
The Federal Reserve Bank of New York said today that it would expand its counterparties for conducting reverse repurchase agreement transactions.
“This expansion is intended to enhance the capacity of such operations to drain reserves beyond what could likely be conducted through the New York Fed’s traditional counterparties,” the NY Fed said in a statement.
The NY Fed has been testing “reverse repos” since last December in preparation for eventual monetary policy tightening and as early as last October had announced that it would expand its counterparties for these transactions.
Reverse repos are one of the tools the Fed has said it plans to use to drain excess reserves from the financial system once it begins its exit strategy in earnest. But Ben Bernanke, Fed chairman, has made clear that he does not expect it to be the primary tool – rather, the Mr Bernanke intends to use the interest rate the Fed is paying on its holding of bank reserves to be the “most important” technique for draining the funds. Read more
Once it stops snowing, Ben Bernanke will talk – with great conditionality – about possible exit strategies from the various measures the Fed has introduced since the crisis. Each of the measures will enjoy very different exits.
First, the Fed’s provision of temporary lending (paragraph 10). “The exit from these programs is substantially complete,” Bernanke will say, at no loss to the Fed, and no expected loss in future. Peaking at $1,000-$1,500bn at the end of 2008, total credit outstanding now stands at $110bn.
Second, buying securities. The Fed made large-scale purchases of Treasury and agency securities to increase the stimulus (par 3). But “I currently do not anticipate that the Federal Reserve will sell any of its security holdings in the near term,” Mr Bernanke will say (par 20). Securities will be allowed to roll-off or mature, but selling them off – for further tightening – would only be possible once policy tightening is underway and the economy is safe.
Third, exceptionally low interest rates (par 19). The exit strategy is to get markets ready by soaking up excess reserves Read more
If the Fed is bothered about primary dealers lacking the balance sheet capacity to do reverse repos on a large scale, why not use its regulatory powers to ease these constraints? The Fed might want to do as much as $500bn in reverse repos. The dealers have balance sheet space for $100bn at most.
A short-term reverse repo with the central bank ought not to be the kind of asset a bank needs to set much capital aside for, nor the kind of asset that counts against crude leverage limits. I am not an expert on the regulatory side of this but I suspect the Fed might be able to do something about this if it put its mind to it. Read more
Bernanke confirmation special
The Fed would like to mop up a decent share of its excess reserves to reduce the pressure on the paid interest facility and it’s eying the money-market mutual fund industry to help, writes Krishna Guha of the Financial Times Read more
Now the Treasury Department has increased pressure on the Fed’s untested techniques for exiting stimulus measures, should the Fed perform trial runs, asks Krishna Guha of the Financial Times Read more