Fed´s usefulness is waning

According to Bernanke:

In general, with policymakers sounding more agnostic and increasingly disinclined to provide clear guidance, Fed-watchers will see less benefit in parsing statements and speeches and more from paying close attention to the incoming data. Ultimately, the data will inform us not only about the economy’s near-term performance, but also about the key parameters—like y*, u*, and r*—that the FOMC sees as determining that performance over the longer term.


The Fed Will Fail

A Benjamin Cole post

House prices feed heavily into U.S. inflation rates as measured, and as pointed out by Kevin Erdmann of the excellent blog Idiosyncratic Whisk, there is hardly inflation at all but for housing costs.

The matters little for U.S. Federal Reserve officials or the gaggle of inflationistas who monomaniacally jibber-jabber about prices. At every juncture, monetary policy is about the perils of inflation and the need to raise rates.

But, as noted by many, from here the Fed cannot tighten its way to higher long-term interest rates. The United States is in that monetary zone long ago noted by Milton Friedman: Interest rates are low as a consequence of tight money.

The present-day reality is this: Easy money for years on end does not lead to sub-2% 10-year US Treasuries, which we see in the market now.

And Fed policy gets more confounding.  If the Fed raises rates, it will only succeed on the short-end of the curve. As money is already tight, long-term rates will sag, and that includes long-term mortgage rates.

Okay, so lower long-term mortgages rates, ceteris paribus, lead to higher house prices and thus higher rents, as rents are tried to house prices.

Of course, the real solution to high housing costs in the United States is twofold, involving aggressive upzoning or dezoning of property in high-cost cities, and a looser money policy and extension of credit to home-building industries and buyers.

An aggressive pro-growth monetary policy might actually result in prosperity and higher long-term rates. Oddly enough, the higher mortgage rates might somewhat depress house prices and related rents, which feed into reported inflation.

As it stands, there is little the Fed can do about property zoning, which is a local prerogative. At the last Fed shindig in Jackson Hole, every panel discussion was about inflation, but none mentioned property zoning. I would call this a blind-spot, but that would suggest the Fed has eyes.

In any event, the U.S. property-owning class in each city seems content to zone out competition, and is politically powerful. In the real world, prosperity in the United States will incur moderate inflation, in large part due to housing costs.

The Fed’s chosen solution is to prevent prosperity, but that is a central banker’s fix and not a good one. The Fed’s better recourse from here is to shoot for higher long-term growth and interest rates, and moderate inflation, by any means necessary, including helicopter drops.

Of course, the best course is targeting NGDPLT.

The Fed is likely to enter the next recession with interest rates near the zero-bound and inflation dead. Then what?

Markets to Fed: “Stop talking nonsense”

A James Alexander/Marcus Nunes post

The FOMC statement today clearly tried hard to tell the market that the economy was improving,  signaling the “door is open for a September hike”!

“The labor market has “strengthened,” the Federal Open Market Committee said after its two-day meeting. That was brighter than the FOMC’s assessment six weeks ago, when the central bank said the pace of improvement in jobs growth had “slowed.” Moreover, officials described household spending as having been “growing strongly,” and economic activity as expanding at “a moderate rate.” That marked a mild upgrade from June, when the Fed said household spending had strengthened and economic activity appeared to have picked up.”

But … since mid-2014, the Fed’s own Change in Labor Market Conditions is still weakening, if a bit less than earlier in the year. Household spending in nominal terms is still awful, even if lowflation means real spending looks OK. NGDP growth is also sliding down. We know that money illusion means people certainly won’t feel better and low nominal growth does no favors  to productivity growth. The Price Pressures probability, calculated by the St Louis Fed, also shows price pressure is absent.

JA Stop Nonsense_1

JA Stop Nonsense_2

JA Stop Nonsense_3

Today’s FOMC statement followed on from the transparent spinning we spotted last week by the Fedborg.

In fact, three bits of data that came out today were all weaker than expected all in different areas of the economy: durable goods, pending home sales and stronger oil inventories. A “moderate rate” of expansion is just plain wrong.

The markets certainly reacted quickly, first seeing a rise in the USD and bond yields before shock kicked in that the Fed had lost touch with reality and both the USD and bond yields fell. Technically the first impact is the liquidity impact of tighter money followed by the Fisher effect of longer term expectations driving prices.

The feedback loop we identified  in monetary policy seems to be working very quickly these days, hours, minutes. In fact, it is on the way to collapsing to a single point: “Whatever the FOMC says, there will be no tightening”!

If talk matters, why not change the subject matter?

Timothy B Lee summarizes thus:

This pattern — the Fed talking about imminent interest rate hikes but then delaying them due to disappointing economic performance — has been playing out for a couple of years. A lot of commentators simply treat it as bad luck, with the Fed as a mere spectator. But that misunderstands what’s going on.

In reality, the Fed’s constant chatter about raising rates is itself an important cause of the economy’s sluggish performance. Markets and business leaders pay close attention to Fed statements. When Yellen signals that higher interest rates — and, consequently, slower growth — are imminent, companies respond by cutting investment spending. The result is a self-defeating feedback loop.

Cry Wolf_1

Imagine if, from today, the Fed instead of “rate normalization”, began to talk about “spending level normalization”. Quite likely, a self-reinforcing feed-back loop would take hold. Instead of “slumming” we might just start “going somewhere”!

Talk Matters

“Headwinds”: Code for “Fed”

Ms. Yellen has said headwinds are holding back the economy. Right! The Fed is working full-time to that end. And, if they continue their quixotic search for the “neutral rate”; if they continue to believe inflation will climb to target sometime in an unknown future date; if they continue to believe the labor market is “strong”; they will be surprised to see the fed funds rate remaining unchanged for “years to come”!

The FOMC is content playing “loves me, loves me not”, not with daisies, but with data

Love me love me not_1

And never realizes that it´s not the Fed who´s “data dependent”, but it´s the data that is “Fed-dependent”!

So they frequently have to go through some contortionism, like this “tongue-twisting” comment from Atlanta´s Dennis LockhartLove me love me not_2

The [employment]report was not a sign that the economy was slowing, he said. It could be the “natural slowing” in job creation as the economy gets closer to full employment, he said.

Parrots at the FOMC

Repeat after me:

  1. “economy getting close to full employment”
  2. “inflation will soon climb to 2%”

So that you can then say:

  1. “a rate hike will take place soon”

In the not-so-distant future, people will realize that the “gradual normalization” strategy for monetary policy was a most stupid choice!

One of the reasons is that it “keeps out evidence”, in particular evidence that wouldn´t be consistent with their view of necessary “normalization”.

Two pieces of evidence available to policymakers contest their “mantra” about employment and inflation.

The Kansas City Fed calculates a Labor Market Conditions Indicator. The chart shows that for the past two years the changes have trended down and lately have turned negative.


The St Louis Fed calculates a Price Pressure Measure:

Policymakers usually want to know—to the extent possible—the probability that inflation over the next four or eight quarters will exceed the inflation target.

To help policymakers, financial market participants, and others who have an interest in assessing future inflation probabilities, the Federal Reserve Bank of St. Louis has developed an index called the price pressures measure (PPM).3 The PPM measures the probability that the expected inflation rate (12-month percent changes) over the next 12 months will exceed 2.5 percent.

And here´s the chart with the probabilities since January 2012 when the 2% target became official.


Contrary to what the “Parrots” chant, the probability that inflation will exceed the target going forward, has been diminutive!

Unfortunately, the “gradual normalization” strategy ignores all that!

The “Overly Optimistic” Fed

In “Reluctant Parties: The Fed and the global economy”, Gavyn Davies writes:

To judge from last week’s surprisingly hawkish FOMC minutes, which I had not expected, the Fed seems to be reverting to type (see Tim Duy). Many committee members have downplayed foreign risks and have returned to their earlier focus on the strength of the domestic US labour market, which in their view is already at full employment.

In his column today for Bloomberg View, Kocherlakota writes:

This kind of uncertainty — about which goals will define the Fed’s policies — is not healthy. Consumers and businesses can’t make good decisions if they don’t have a strong enough sense of how the central bank will act in any situation. Fed officials must have — or be given — a much clearer set of shared objectives for managing the economy.

To wrap up, commenter Bill sent me “Why the Unskilled Are Unaware: Further Explorations of (Absent) Self-Insight Among the Incompetent”:

People are typically overly optimistic when evaluating the quality of their performance on social and intellectual tasks. In particular, poor performers grossly overestimate their performances because their incompetence deprives them of the skills needed to recognize their deficits. Five studies demonstrated that poor performers lack insight into their shortcomings even in real world settings and when given incentives to be accurate. An additional meta-analysis showed that it was lack of insight into their own errors (and not mistaken assessments of their peers) that led to overly optimistic estimates among poor performers. Along the way, these studies ruled out recent alternative accounts that have been proposed to explain why poor performers hold such positive impressions of their performance.

I just became more pessimistic!

“If I had a hammer” & “When will they ever learn”

From the FOMC Minutes

Most participants continued to expect that, with labor markets continuing to strengthen, the dollar no longer appreciating, and energy prices apparently having bottomed out, inflation would move up to the Committee’s 2 percent objective in the medium run.

Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.

Some participants were concerned that market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly over the intermeeting period how the Committee intends to respond to economic and financial developments.

They want markets to play Keynes´ “Beauty Contest Game”. However, market participants look at the same data that the Fed does. And markets don´t see objective reasons for the Fed to (explicitly) tighten.

The dollar, which reversed trend shortly after the April meeting, rose and will continue to rise to reflect the renewed passive tightening! When will they ever learn?

The Fed creates the “Ugly Duckling”

Ugly Duckling_1

Tim Worstall writes:

The reason this time is different is because, well, this time is different.

Let´s be more precise. The reason this “time is different” is because monetary policy has acted very differently, compressing spending growth thus, turning the 2007 cycle into the “Ugly Duckling”!

Ugly Duckling_2

PS BTW, The Atlanta Fed GDPNow nailed it. The average of it´s 13 successive Q1 RGDP forecasts (annualized) was 0.58%!