The declines in the prices of bonds and many risk assets since the Fed’s policy announcements last week have followed a sharp rise in the market’s expected path for US short rates in 2014 and 2015. This seems to have come as surprise to some Fed officials, who thought that their decision to taper the speed of balance sheet expansion in the next 12 months, subject to certain economic conditions, would be seen as entirely separate from their thinking on the path for short rates. Events in the past week have shown that this separation between the balance sheet and short rates has not yet been accepted by the markets.
The FOMC under Chairman Bernanke has worked very hard on its forward policy guidance, so there is probably some frustration that the markets have “misunderstood” the Fed’s intentions. Richard Fisher, the President of the Dallas Fed, said that “big money does organise itself somewhat like feral hogs”, suggesting that markets were deliberately trying to “break the Fed” by creating enough market turbulence to force the FOMC to continue its asset purchases. Read more
Today’s FOMC minutes suggest that the detailed record of meetings will still be interesting even after the Fed chairman has given a press conference and the best bit – the economic forecasts – have been released.
The minutes of the April meeting are notable for a detailed discussion of exit strategy. Much of this is familiar: it reaffirms the rough ordering of: (1) Stop reinvestments; (2) Change forward guidance; (3) Drain reserves; (4) Raise short-term rates; (5) Sell assets. Read more
Don Kohn, former vice chairman of the Federal Reserve, has just apologised for his errors in the financial crisis in front of the UK Treasury Select Committee, the equivalent of a Congressional committee.
He said he had “learnt quite a few lessons – unfortunately” from the financial crisis, including that people in markets can get excessively relaxed about risk, that risks are not distributed evenly throughout the financial system, that incentives matter even more than he thought and transparency is more important than he thought. Similar to Alan Greenspan’s mea culpa of 2008:
“I made a mistake in presuming that the self interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders”.
Mr Kohn told MPs Read more
The New York Fed’s latest quarterly report on household credit conditions is quite upbeat and somewhat at odds with the latest senior lending officers survey.
Especially interesting are the data on ‘transitions’, which show fewer new mortgages going bad, and some bad mortgages getting better.
It is early days but the Fed’s first press conference seems to have done its job: speeches by regional Fed presidents last week caused little market reaction after chairman Ben Bernanke set out a view for the FOMC on 27th April.
The sample is hardly big enough for statistical significance and recent economic data hardly supported the outspokenly hawkish views from the regional banks that often perturb markets.
But even if the press conferences do improve how the Fed communicates, and dampen the volatility of market responses, the real problem is what the Fed communicates. The Fed still does not communicate two things: (1) a clear numerical objective for policy; and (2) any idea of the monetary policy path it expects to use to get to its objective. Read more
John Williams, the new president of the San Francisco Fed, has delivered his first speech. It wasn’t a thriller but I guess his term will be long enough that he need not hurry to excite the markets.
Mr Williams stuck to mainstream Fed thinking but he did set down a few markers. He forecast that growth will bounce back to above 3 per cent for Q2, that total growth for 2011 will be about 3.25 per cent, and that unemployment will end the year at 8.5 per cent. He also sets out his preferred inflation objective of 2 per cent – putting him with the large majority of the FOMC. Read more
I’ve been thinking about what Fed chairman Ben Bernanke said in his press conference about reinvestment of maturing assets from the Fed’s portfolio.
“At some point, presumably early in our exit process, we will – I suspect based on conversations we’ve been having around the FOMC table it’s very likely that an early step would be to stop reinvesting all or a part of the securities which are maturing. But take note that that step, although a relatively modest step, does constitute a policy tightening, because it would be lowering the size of our balance sheet and therefore would be expected to essentially tighten financial conditions.”
If it is the stock of Fed assets that matters, as the Fed believes, there is no doubt that this is literally correct. Reduce the size of the balance sheet and you tighten monetary policy.
But the direct tightening would be incredibly small. I think a much more pertinent reason for Mr Bernanke’s comments is to send a signal that short-term interest rates are going to stay low and discourage the market from pricing in an earlier tightening. Read more
Rates are held, as expected, and QE2 is expected to continue till June. But all eyes will be on Bernanke for any signals of change at the new press conference (see video). For live blog commentary, see Gavyn Davies‘ real time post or his earlier thoughts.
The US lacks a “credible strategy” to stabilise its mounting public debt, posing a small but significant risk of a new global economic crisis, says the International Monetary Fund.
In an unusually stern rebuke to its largest shareholder, the IMF said the US was the only advanced economy to be increasing its underlying budget deficit in 2011, at a time when its economy was growing fast enough to reduce borrowing. The latest warning on the deficit was delivered as Barack Obama, the US president, is becoming increasingly engaged in the debate over ways to curb America’s mounting debt. Read more
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: