Central bankers were in Jackson Hole this week discussing “Resilient Monetary Policy Frameworks for the Future”. Janet Yellen grabbed the headlines with the opening speech on Friday: “The case for an interest rate hike in 2016 has strengthened”.
It is a pleasant fiction!
Strong U.S payroll data in June and July, supported the argument to increase rates. Payroll, increases of 292,000 in June and 255,000 in July were above the five year month average of 210,000. Core inflation PCE at 1.6% is moving towards the Fed target.
Growth in the second quarter was just 1.2% following revised growth of 1.6% in the first quarter. U.S. growth is likely to be around 1.5% this year down from 2.4% in 2015. Disappointing GDP figures will inhibit the push to increase rates.
Markets expects the Fed to hike rates in December with a less than 25% probability attached to an earlier September rates rise. The Fed is unlikely to hike rates any time soon.
Fed concerns continue …
The Fed remains concerned any further move would damage growth, hit the bond markets, damage stock markets, inflict currency turmoil and undermine the recovery in emerging markets.
Financial markets crashed in 2013 when the Fed hinted that it would begin to tighten monetary policy. The “taper tantrum” revealed that several major economies, including Brazil, were still addicted to cheap debt after borrowing heavily in the US currency.
Since then the crisis in Brazil has deepened, Abenomics is struggling yet again in Japan, EU rates are negative and the Bank of England has announced further rate cuts and another round of QE.
Janet Yellen may continue to “hint” at a rate rise but the Fed chair is quick to point out “Decisions depend on incoming data”. There is a lot of data. The Fed forward funds rate forecast ranges for 0% - 5% by the end of 2018. So much for incoming data and forward guidance.
Stuck on Planet ZIRP ...?
Central bankers are stuck in a hole not just in Wyoming. Hotel California is on Planet ZIRP. “You can check out anytime you like but you can never leave”.
There is a serious problem with monetary policy. Interest rates pushed to the lower bound together with QE are unproven facets of policy with no empirical exposure to effect.
“Ill considered new dogmas pushed into the mainstream of monetary policy” the verdict of Kevin Warsh a former member of the Federal Reserve Board and now at Stanford, writing in the Wall Street Journal this month.
The Fed wants to restore some semblance of order to monetary policy without damaging equity and bond markets into the future. The problem is that interest rates at the lower bound together with QE have distorted capital markets. Ten year bond yields at 0.6% in the UK are a representation of the problem, not the success.
In the UK £450 billion is the target for QE spending, US $3.7 trillion the budget in the USA. In the UK, USA and Europe central bank assets are over 20% of GDP. In Japan with the 80 trillion yen ($796 bn) annual bond-buying programme, central bank holdings are heading for 80% of GDP.
BOJ's Kuroda recently said he would not rule out a “deepening cut” to the country’s negative interest rates. ECB's Draghi has followed the Japanese into negative territory, dragging the Swedish, Danish and Swiss national banks into the NIRP crevasse.
For some strange reason the Bank of England panicked into rate cuts and further QE this month. UK data this week suggests the Governor jumped the gun in fears over Brexit. At least Carney and Yellen are ruling out negative rates.
Bernanke and Shifting Perspectives …
Former Fed Chair Ben Bernanke recently penned another of his Brookings Institute blog entries, called “The Fed’s shifting perspective on the economy and its implications for policy”. His summary:
“It has not been lost on Fed policymakers that the world looks significantly different in some ways than they thought just a few years ago. The degree of uncertainty about how the economy and policy will evolve may now be unusually high.”
What does that mean? Bernanke admitted that we had no idea what we were doing when we introduced QE. Since then, Fed projections have been wrong, and the central bank doesn’t know how to make them any better in the future. Worse still you begin to believe the Fed has no idea how to get out of this mess.
QE has unintentionally created the biggest bond bubble in history boosting equity markets in the process. The role of the central bank is not to maintain bonus structures on Wall Street. How to explain the withdrawal to the addicted few?
Don’t be baffled by new think concepts of Larry Summers, “secular stagnation” brought about by ageing Population, Low Productivity, Spending and Investment. What if low spending and investment are a function of interest rates at the lower bound and QE, inhibiting savings and productivity growth?
Neither should we be baffled by the concept of the floating equilibrium real interest rate, a justification for low rates in a low growth environment. It is said that In a slowly growing economy, the equilibrium real rate is likely to be low, since investment opportunities are limited and relatively unprofitable. Yet investment opportunities and the search for yield are inhibited by central bank intervention driving down yields on government and corporate bonds.
Extraordinary Popular Delusions and the Madness of Crowds : Charles Mackay 1841
The adventures on Planet ZIRP, with profligate QE spending, drifting into the NIRP crevasse will one day make a chapter update in the future edition of Extraordinary Popular Delusions and the Madness of Crowds. Tulip bulbs trading higher than gold? Ten year gilts yields lower than inflation. “Why do otherwise intelligent individuals form seething masses of idiocy when they engage in collective action? Why do financially sensible people jump lemming-like into hare-brained speculative frenzies--only to jump broker-like out of windows when their fantasies dissolve?" Mackay's classic--first published in 1841--shows that the madness and confusion of crowds knows no limits, and has no temporal bounds.
What if there is a recession …
More worrying still in a recent paper by Fed staff economist David Reifschneider, Reifschneider asks the question “What if there is a U.S. recession before the Federal Reserve has the chance to “normalise rates”. Janet Yellen’s response suggests the current monetary framework is up to the task. Rate cuts, $2 trillion of QE and forward guidance, should be enough to solve any growth problem claimed the Fed Chair in the speech yesterday! $2 trillion, how so exact?
More of the same does not appear to be the solution to creating “Resilient Monetary Policy Frameworks for the Future”. The call should be made to end QE and produce a co-ordinated central bank response to “normalise” short rates and term bond rates in Europe, Japan and the USA. The locomotive theory of monetary policy should be enacted. In which all pull together to escape the gravitational pull of Planet ZIRP.
So why Jackson Hole …?
If central bankers are so smart, why are they in Jackson hole anyway? The Jackson Hole economic symposium is an annual gathering of the world’s leading central bankers in the Grand Teton mountain region of Wyoming. The meeting has been hosted since 1978 by the Federal Reserve Bank of Kansas City, which chooses a topic for the event.
Initially concerned with farming and agriculture, in 1982, the theme for the symposium changed to broader economics and monetary policy. Fed Chairman Paul Volcker was the “catch”, fly fishing at Jackson hole the “lure”. Why Jackson Hole? They are there because of the fly fishing!
Not initially the best place for communications, delegates would be informed “to obtain today’s copy of the Wall Street Journal, you would have to come back tomorrow”.
One suspects to “Create Resilient Monetary Policy Frameworks for the Future” we may best get the answer, not today tomorrow but ... next year may yet be too soon.
So what happened to Markets?
Markets, were down - The Dow closed at 18,541 from 18,598. The FTSE closed down at 6,845 from 6,854.
Sterling moved up against the Dollar to $1.3201 from $1.3125 and moved up against the Euro at €1.170 from €1.159. The Euro moved down against the Dollar to 1.128 from 1.132.
Oil Price Brent Crude closed at $48.56 from $50.89. The average price in August last year was $46.52.
Gilts - yields moved up. UK Ten year gilt yields closed at 0.55 from 0.56. US Treasury yields moved to 1.56 from 1.55. Gold closed at $1,347 from $1,350.
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The material is based upon information which we consider to be reliable but we do not represent that it is accurate or complete and it should not be relied upon as such. We accept no liability for errors, or omissions of opinion or fact. In particular, no reliance should be placed on the comments on trends in financial markets. The presentation should not be construed as the giving of investment advice.