The great Fed rethinking having minimal impact – so far

A James Alexander post

Everyone and his dog seem to be weighing in on the Fed’s “rethinking”. The only thinking that really matters is those of the folks on the FOMC (and maybe Bernanke). It is still encouraging, nonetheless. We have been posting on this “new thinking” since April at least. We especially liked the often-neglected Daniel Tarullo’s interview from early July.

William Dudley, the no.2 to Yellen on the FOMC, also gave an important but neglected speech in Indonesia a few weeks ago where he switched from suggesting the usual mantra that monetary policy was “highly accommodative” to saying it was only “moderately accommodative” A big change. He is now only moderately wrong rather than completely wrong..

He also, rather weakly. stated:

“As I noted earlier, I think the medium-term risks to the U.S. economic growth outlook are somewhat skewed to the down side. Thus, this needs to be taken into consideration in terms of the appropriate stance for U.S. monetary policy. With respect to the efficacy of monetary policy, given how close we remain to the zero lower bound for interest rates, I also think the risks are asymmetric. Therefore, we need to be a bit more careful about the risk of tightening monetary policy in a manner that proves to be premature, as compared to the alternative risk of being a little late. If we were to realize that we were slightly late, policy can be adjusted by raising short-term interest rates more quickly.”

All that said, the only reaction that would prove that the rethinking is having any actual impact is if medium term expected NGDP growth were rising. The evidence here is less encouraging. There is no market for NGDP growth expectations yet, so we are left with implied NGDP growth expectations.

  • The S&P500 has hit record highs. Good.
  • The USD has drifted down a bit from recent near term highs, but is still very much in its medium term channel. Neutral.
  • US bond markets at the short end suggest a rate hike after the election is probable. The medium and long end are at record low yields and the 10-2yr bond spread is back at record post-crisis lows. Bad
  • Commodities suggest no great upsurge in NGDP growth despite a modest recent rally in oil.

There may be stuff that obscures the messages from financial markets. Things like the relative monetary policy of non-USD currency blocs are as easy as the US, or easier, rendering the USD a tricky gauge of monetary policy. The supposed “safe asset shortage” could be masking what would otherwise occur in bond markets, that is, the liquidity effect is more than offsetting the Fisher (expectations) effect. Maybe, but markets tend to get things right in the end.

Perhaps this year´s Jackson Hole will provide some answers. It certainly adds to the usual weight of expectations on Janet Yellen’s speech on August 29th. The title of Designing Resilient Monetary Policy Frameworks for the Future  for this year’s workshops is a bit more encouraging

PS The great silver lining in the UK is that all the Brexit bears inside the insular metro-London elites who’ve apparently taken positions against the GBP and various equity proxies will get blown out of the water. Yeh!

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