US

Robin Harding

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.”

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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

Robin Harding

(1) There is no need to panic. After the purchasing managers’ index for manufacturing came in below 50 on Monday there was some cause to worry about the health of the economy – but the rise in the services PMI, from 53.1 in April to 53.7, suggests that consumer demand is still there.

Implications of US May ISM Non-Manufacturing (KAUC6001) Read more

Michael Steen

One of the benefits of the European Central Bank’s new household finance and consumption survey is that it allows eurozone household data to be compared with that of the US, since the surveys use comparable methodologies.

The survey already caused something of a stir in Germany earlier this week because it appeared to show that the typical Cypriot household was better off than the typical German one. (In 2010, anyway, and subject to a lot of caveats and nuance, summarised in the story.)

Today’s ECB monthly bulletin also picks over some of the data in the HFCS and highlights this ability to compare data with the US Federal Reserve’s Survey of Consumer Finances. One interesting tidbit it points out is quite how much wealth distribution differs between the US and (the euro-wielding corner of) Europe. Read more

Chris Giles

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

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

Many investors fear that the Fed’s impending exit from QE2 will have a very damaging effect on the financial markets. Whether they are right will depend on the nature of the exit, and its impact on bond yields. An end to the Fed’s programme of bond purchases, without any increase in short rates, is unlikely to be sufficient, on its own, to trigger a major bear market in bonds and equities. But an end to the Fed’s “extended period” language on interest rates would be a much greater threat. I still do not expect this to happen soon.

Recently, the Fed has purchased 60-70 per cent of all the bonds which have been issued to finance the US budget deficit. Some influential analysts (Bill Gross of Pimco among them) argue that bond yields will rise sharply when the Fed withdraws its life support from the bond market. But there are some powerful advocates, including the Fed chairman himself, for an entirely contrary point of view. Ben Bernanke told Congress in February that he did  not expect to see “a big impact” on bond yields when the Fed ended its asset purchases.

The Fed has hardened its thinking on this question in the past couple of years. It has  decided that QE reduces bond yields via its effect on the total stock of outstanding bonds, and not via its impact on the flow of bonds purchased in any given period. If this is the case, then

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Robin Harding

I’ve been off helping in our Tokyo bureau for ten days so time to catch up on the Fed news.

The March FOMC meeting

The committee took the opportunity to do a substantial rewrite of the first two pars of its statement, which made sense, as it was starting to get pinned down by fear that any change would be seen as a signal of early changes to QE2.

The main effect of the rewrite is to focus the statement on the danger of high headline inflation – but make clear that the FOMC expects it “to be transitory”. I’m a touch surprised by the transitory line given that some members of the committee are clearly concerned that it will be otherwise. Read more

Robin Harding

…is starting to look quite convincing.

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No stress tests for ages, then they all come along at once.

Some banks are set to raise their dividends imminently in the US, once the Fed gives them the green light ahead of detailed stress test results released in secret next month. Another practice put on hold in 2009 – share buybacks – will also be back on the menu for some of the 19 large banks. Only those groups that wanted to increase dividends or share buy-backs, or repay government capital, received a call from the Fed on Friday. Those receiving good news will no doubt act swiftly: any of these activities will presumably be seen as a public badge of honour, in the absence of results publication.

Europe, meanwhile, does intend to publish results. Arguably the target audience for Europe’s stress tests is investors and markets rather than the banks themselves. This might give the unfortunate impression that policymakers are aiming for the appearance of a healthy banking sector rather than the real thing. Read more

Import prices in February climbed much faster than expected, as did producer prices, and the Federal Reserve adjusted the language in its latest FOMC statement to reflect the “upward pressure” on inflation from higher commodities prices.

But today’s CPI release showed that inflation in February was only slightly higher than consensus, so there probably won’t be any market surprises based on this — not with the extraordinary events happening elsewhere in the world. The headline number was up 0.5 per cent last month, and core grew by 0.2 per cent.

Still, the year-over-year gap between headline and core inflation continues to widen impressively. These are still low levels for both, but it’s worth mentioning that February was also the second straight month in which core inflation grew at 0.2 per cent — after not having exceeded 0.1 per cent since last June.

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Robin Harding

Macroadvisers have put out their estimates of the economic effect of passage of the House Republicans $61bn of FY11 spending cuts. They are lower than Goldman Sachs, higher than the Fed, and look pretty solid to me.

  • Our simulation analysis suggests this near-term fiscal drag would reduce annualized growth of real GDP during the second and third quarters of this year by ¾ percentage point, with smaller impacts for a few subsequent quarters.

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Robin Harding

Data from the Treasury International Capital system have always got a lot of stick. The system is meant to show foreign holdings of US assets broken down by country (and vice versa) but has a big problem with ‘custodial bias’: it struggles to track funds beyond the financial centre where they are held, e.g. the UK, Switzerland, the Channel Islands, various dodgy Caribbean destinations etc.

Recent sanctions on Libya have created a fascinating natural experiment on just how big that ‘custodial bias’ actually is. Does the amount of Libyan assets in the US reported to TIC match up with the amount of Libyan assets frozen in the US? Answer: a resounding ‘No’. Read more

It’s only five basis points but it’s the direction that matters. Federal reserve banks cut the seasonal discount rate at its last meeting to 0.2 per cent.

The seasonal discount rate is typically aimed at small banks in agricultural or tourist areas, where businesses’ and individuals’ borrowing needs are highly seasonal. The rate, as you can see, has gone lower, to 0.15 per cent. During talk of green shoots in mid-2010, the seasonal rate reached the heady heights of 0.35 per cent before heading down to a fortnight spell at 0.2 per cent in November. To give some context, the average since 1996 is 3.5 per cent.

James Politi

In Ben Bernanke’s testimony before the Senate banking committee today, there was plenty of talk about US fiscal and budgetary policy.

It’s the hot topic on Capitol Hill, with Congress moving this week towards a deal to cut spending by $4bn and avert a government shutdown – at least for two weeks.

Needless to say, in the question-and-answer session, lawmakers from both parties were desperately trying to get the Federal Reserve chairman’s approval for their positions.

Republicans are advocating for aggressive cuts in discretionary spending, while Democrats, in the words of Harry Reid, the Senate majority leader, want to apply a ”scalpel” rather than a “meat axe” to the US budget. Read more

James Politi

The US is little more than $200bn away – or about 2 months – away from reaching its congressionally mandated national debt limit of $14,300bn.

The need to increase it to avoid a potentially disastrous US default is the next fiscal battleground in Washington, after the lawmakers stop squabbling over a government shutdown.

Republicans want to use the opportunity to push for more spending cuts, while Democrats say this is not the place to negotiate.

On Thursday, Moody’s Investors Service offered its analysis of the likelihood that a major crisis will ensue, threatening America’s triple-A credit rating much earlier than even the most ardent fiscal hawks would imagine. Read more

Robin Harding

I’m not sure quite why Bernd Hayo and Matthias Neuenkirch of Philipps-University in Marburg, Germany, care about the behaviour of regional Fed presidents, but their latest working paper will interest Fed-watchers.

They took 612 speeches by members of the FOMC up to September 2009 and then coded them as ‘tightening’ or ‘easing’. Then they tested against economic variables to see what was motivating the speech.

Our results are, first, that Fed Governors and presidents follow a Taylor rule when expressing their opinions: a rise in expected inflation (unemployment) makes a hawkish speech more (less) likely. Second, the content of speeches by Fed presidents is affected by both regional and national macroeconomic variables. Third, speeches by nonvoting presidents are more focused on regional economic development than are those by voting presidents. Finally, voting presidents and Governors are less backward-looking in their wording than are nonvoting presidents.

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Robin Harding

The headlines from the Fed minutes are thoroughly covered on ft.com so a few more subtle points here.

What was day one of the two day meeting about?

Structural unemployment. It’s not a surprise that the FOMC wanted to discuss this given how important the degree of slack in the economy is for future policy. The summary in the minutes is feeble and gives no real sense of the committee’s conclusion – although maybe they didn’t reach one. The closest it comes is this:

Most of the research reviewed suggested that structural unemployment had likely risen in recent years, but by less than actual unemployment had increased.

Which is a statement of the blindingly obvious. It is a bit of a missed opportunity to put this issue to bed since I think there are few people in the Fed system who believe that structural unemployment will become a binding constraint any time soon. Read more

It is no secret that China’s appetite for Treasuries has been waning. Official figures now bear out Beijing’s stated desire to diversify away from US government debt. The market impact is likely to be muted for now, given the Federal Reserve’s bond-buying under its “quantitative easing” programme. But what happens when QE2 ends in June? Beijing’s pull-back may then become noticeable.

The US Treasury market occupies the centre of the global financial system. It is the deepest and most liquid bond market in the world, and demand from central banks and institutional investors, including private sector banks and hedge funds, has allowed the American government to finance its multibillion-dollar budget deficits. Read more