MISCOMMUNICATION AT THE FED: Who’s the “Adult at the party?” MAS092115

During the Bernanke era, the FOMC made strides to create more transparency about the intended course of monetary policy. This was done with the view that monetary policy changes should be better understood by the public (the markets), and that this understanding would give both transparency of Fed actions but also that monetary policy itself would be more effective by making that policy more transparent.

In fact, the so-called “Woodford Doctrine,” elucidated at an earlier Jackson Hole conference (August, 2012), seemed to imply that the Fed actually possessed an additional weapon in its tool arsenal by communicating its long run policy guidelines. Woodford, of course, had advocated a simpler guideline, nominal GDP, to avoid potential situations of conflict between the explicit dual mandate of output and inflation. Woodford felt sticking to the guidelines was a powerful weapon for the Fed.

Given the dual mandate of output (employment?) and inflation, Woodford’s prescription should have given the Fed a kind of channel within which the Fed could and should operate. He did allow for the ambiguity of potential conflict between the two targets but long term guidance was not to be disturbed without clear indication that something very fundamental had changed: No surprises; clear intentions: longer run predictability of actions. Who really could argue with that?

Rumor has it that the ”adult at the party,” was less clearly disposed to accept this as a guidance criterion for the Fed. Fischer’s approach at Jackson Hole 2016 (See Ecomentary.com “Off the Table-On the Table: the Fischerine Query,” August 31 2015) seemed to imply that no firm channel existed or was even desirable. Some critics of Fed policy could note that the dual mandate criteria might well be insufficient as a guideline of Fed future policy. It appears to this observer that Fischer has had his way at the FOMC meeting of September 17, and the ambiguous statement of policy intentions contained in the Yellen Press Conference following the FOMC meeting that day is now the name of the game.

The press conference walked away from the dual mandate criteria and introduced external economic conditions as a compelling reason for the Fed to “wait a bit longer” before implementing its first dose of a return to monetary policy normalcy. It is to be noted that only a solitary dissent by District bank President Jeff Lacker accompanied the decision. To this observer the title of “adult at the party” has changed hats!

Bernanke’s view of transparency to which the market thought Yellen had subscribed was that abrupt and uncommunicated policy shifts were nugatory at best, damaging at worst and clearly not effective forward policy guidance. While Bernanke didn’t subscribe to an iron-clad rule (such as one of the versions of John Taylor’s rule or Milton Friedman’s percentage growth rule) it seemed reasonably clear that long term guidance for Bernanke implied the use of the same criteria for FOMC policy shifts, meeting to meeting unless something extraordinary had occurred. Bernanke didn’t exclude the possibility of discretionary actions from its long-term guidance—in the event of striking and unexpected developments in the economy—but it was clearly an attempt by Bernanke to place a bridle on a potentially bucking horse in monetary policy decisions. Where a decisive change in policy had to be installed, it would be in the context of full public pronouncements that the rules of the game had changed from a sharp and unexpected shift in economic conditions. Now comes the Yellen-Fischer concern with American financial policy in light of world developments that were widely known well before the FOMC met on September 16-17.

What’s gone wrong here? First, all of the reasons that Yellen cited for her “patience” policy had long been in the market. China, emerging market fragility, poor growth in Europe were not new conditions. They had been talked about at Jackson Hole and by market observers for many, many months. Meanwhile, the unemployment rate—with all of its weakness as a measure of labor market conditions—was steadily declining; and, Yellen herself had spoken of her wish to view labor market conditions in a larger perspective. As for inflation, the FOMC had said and continued to say that despite very recent deterioration from the 2% criterion, it fully expected prices “in the medium term” to rise up to the 2% target.

While various market reporters had signaled only a 50% probability as to the likelihood of a Fed rate increase, the reaction of equity and bond markets was one of shock. Clearly, the public as a whole had been conditioned to expect that the ‘return to normalcy’ was about to begin. The S&P fell sharply following the widely expected “return,” and world wide markets (closed at the time of the announcement on the 17th) rattled down decisively the next day. Anytime the Fed thinks that world wide conditions are very frail, the market is bound to think the Fed knows something that the market doesn’t know. Could it be that the FOMC with all of its expertise and adults at the party doesn’t know the impact of disappointed expectations? Does the FOMC think that equity markets are a bubble that needs pricking?

What Yellen accomplished at the FOMC meeting and subsequent press conference seemed to violate the long-standing transparency rules that the Fed once had! To put it differently, it was a MISCOMMUNICATION, and that is a polite description.

A more sober assessment is that the market can no longer take the Fed as following its previous communications policy. This Fed is not transparent. It has undermined any credibility that the Bernanke era gave it. The Bernanke rule was really the following: set a course (for the Central Bank); stay on the course in order to anchor expectations in the financial market; deviate only if extraordinary events begin to change that have threatened financial stability. It was a “rule by exception, and the exceptions should be few!

Nothing major has occurred either overseas or in the U.S. except the perpetuation of known trends. Therefore, the market’s expectation of a first rise in the target rate coupled to a trajectory of very slow normalization was “in the game.” The Fed changed its rules. It has miscommunicated. By doing so it may have dislodged its carefully placed anchor.

Investors beware. We are back to a pre-Bernanke Fed—to a world of possible, unexpected shifts in policy. Build more uncertainty into your market forecasts. The Fed has told you to expect less forward guidance that can be relied upon and more (whimsical?) policy making under the guise that the “U.S. is not an island.” We are back to the Greenspan days with its mumbled pronouncements.

Off the Table-On the Table: the Fischerine Query

Jackson Hole Themes and the September FOMC Meeting: is the rate change on or off the table? MAS 8 31 15

It is hard to overemphasize how large the media focus is on predicting whether the FOMC will raise rates at its September. With that backdrop, surely observers at Jackson Hole gave rapt attention to the speech by the Board’s Vice Chairman, Stanley Fischer. Given his well-regarded academic achievements, his tours of duty at the IMF and the Bank of Israel, plus his sojourn at Citibank, outsiders regard his remarks as significant —potential containing clues as to the thinking at the FOMC. Perhaps, both hawks and doves in that birdcage listen more intently to a Fischer squawk than to others, while outsiders often refer to him as the “adult” at the table.
Clearly there was wide interest at any hints Fischer’s speech might produce regarding what the Committee is thinking and what it ought to think about in its rate-setting deliberations next month. The speech is a sober recital of the complexities of gauging where on the projection screen of employment and prices the US economy is at this moment. It is unlikely that it ignited any new conclusions. It was a temperate and thorough discussion on the difficulties of judging the future course of inflation, and how close the Fed might think it is in achieving its stated 2% objective. The speech also did not ignore the importance employment in evaluating the twin mandate, but it put a larger context around the usual focus on the unemployment rate by mentioning the status of older workers, part-time employment as well as the labor participation rate. His careful deliberation on the back of a tumultuous two weeks in equity and exchange rate markets all around the world underlies the Fed’s awareness that US rate changes affect other countries in the world economy.
Here is what we view as his important points regarding inflation.
focused on judging how close current inflation is to the 2% target while emphasizing that concerns should be on the forward path of the inflation rate.

pointed to how close to zero are the changes in the measured inflation rate despite the substantial oil shock.

Observed that the lack of upward changes in prices is only partly explained by issues of slack

Core inflation can be influenced somewhat by oil prices but the larger effect comes from dollar appreciation in terms of expectations and pass-through to GDP growth

Changes in dollar value: the estimated pass-through from import prices to consumer prices occurs relatively quickly within a quarter and the bulk of the overall effect occurs within one year

The effect of dollar appreciation with regard to GDP occurs over a longer time period, and …”it is plausible to think that the rise in the dollar over the past year would restrain growth of real GDP through 2016 and perhaps into 2017.

comment: Fischer doesn’t discuss why it is then if dollar appreciation works to slow GDP, shouldn’t we see that in the labor market? That is not happening so far.

The dynamics of inflation depend upon changes in expectations and expectations have been remarkably stable. Consequently, he sees stable inflation expectations as a dampening force in transmitting exchange rate changes to prices in the US economy.

The relevance of the above is that the FOMC has to assess progress—both realized and expected—toward its 2% objective. The Committee anticipates that it will be appropriate to raise the target range…when it has seen some further improvement in the labor market and it is reasonably confident that inflation will move back to its 2% objective over the medium term.

Fischer highlights the coming Employment Report due Sept 4, but the FOMC’s reaction won’t be a “mechanical one”

The FOMC will also be interested in unemployment of older workers, workers working only part-time for economic reason and the participation rate

Furthermore, FOMC will look prices in terms of the CORE inflation rate. (Here, the interest is whether the movements in the CORE rate give better forecasts of the future inflation rate)

The FOMC is also interested to decipher where the US economy is going, rather than where it has been. (It almost seems like he wishes to disconnect the FOMC from the revised 3.7% real growth rate of the Q2

At this point, the FOMC will also be looking at the effects of a target rate increase on economic activity outside of the USA.

Monetary Policy Ambiguity: Yellen at Jackson Hole

1) Monetary policy has two goals: maximum employment and stable inflation. Policy at any moment of time requires the assessment of where the economy is and where it is likely to go. That assessment is clouded by the inability to specify how much unemployment is cyclical and how much is structural. If the former, possibly it can be treated with monetary policy instruments. If the latter, it is beyond the Fed’s reach.
2) The inflation target has essentially been reached but the Chairwoman, still thinks there is “slack” in the labor market. She concedes that the differentiation between cyclical and structural unemployment is hard to make, but looking at the plethora of indicators in the labor market, she feels that the current level of (monetary) accommodation, is appropriate, particularly in view of the scheduled run off of central bank purchasing of Treasuries and MBS.
3. The difficulty with this assessment is that judging labor market conditions is at best extremely difficult. Forecasting how a continuation of the current policy target will affect labor markets in the future may beyond the Fed’s capability. Certainly, no single labor statistic is sufficient while how to mix them for maximum forecasting is not without controversy. She hints at the research going on within the Fed on a ‘factor’ analysis, but that will not convince markets in the short run
4. Fed guidance in such circumstances is unclear. Worse, using a potpourri of labor market stats will probably confuse markets more than it will enlighten them. Sometimes too much information overpowers common sense.
5. Ad Hoc tinkering or policy rules? At the end of the day, the larger issue of whether to base future policy on statistical babble or to adhere to a well understood policy rule is not treated in this speech. This Fed continually runs away from establishing a clear rule—one that markets might be able to discern
Markets will glean little from this speech. Equity and fixed income markets will continue to oscillate in the absence of clear central bank guidance and the troubling geopolitical events of the day.

Macro Policy temptations and the Neglect of Incentives

What went wrong?
The causes of the financial meltdown of 2007-9 continue to be researched and debated by macro economists and financial analysts. It is likely to be years before a definitive analysis becomes widely accepted. Despite that debate, at least one antecedent to that disaster is present in nearly all explanations: government policy measures over many years to expand subsidies to owner occupied housing for poorer Americans were plagued by faulty incentives.

These incentives had very malign consequences for the financial sector of our economy. Under appreciated risks arising from poorly documented mortgage applications grew prodigiously. Mortgage companies were incented to write mortgages for individuals who could neither afford their ultimate financial obligations nor often understand them. Wholesale funding of such faulted mortgages received huge support from monetary policies that promoted world-wide yield searching. Credit rating agencies were suborned by the profitability of creating triple-A credit ratings for mortgage backed securities. Regulations that required many institutional investors to buy only securities with triple-A ratings created disastrous portfolio incentives. GSE’s were incented to expand their guarantees of subprime and Alt-A mortgage paper. Without question, short run political objectives overran prudential common sense.

It’s baaack
Thoughtful observers of American political economy should be alarmed how the politics of subsidizing the “poor” to acquire housing is ‘back in the game.’ While no one has demonstrated that weak mortgage underwriting standards truly work to reduce long term poverty, appearing to make more credit available to individuals and families that they may not be able to support has undeniable voter appeal. Politicians operate on a short run electoral cycle. Faulty incentives are ignored or buried under political rhetoric.

In the aftermath of the financial panic, tightened standards on mortgage underwriting were the order of the day in 2011. Regulators insisted on a minimum of a 20% down payment or lenders had to retain a minimum of 5% of the loan if the loan was resold to investors. Prior neglect of such incentives had resulted in a serious financial disaster. It appeared that policy makers were moving in the right direction by focusing on inappropriate incentives for poor financial behavior. Sadly, this reform diet has now proven to be too strict for politicians who observe what appears to be an inadequate restoration of the housing sector. The result is bad incentives for mortgage underwriting are back in play.

Under the new compromise, regulators won’t require a minimum down-payment (20% goes to 0%), and broad exemptions for banks and mortgage issuers to retain portions of these securities will be granted. (Ziebel and Ackerman “Softened Mortgage Rule Advances,” WSJ 6/11/2014). Policy memory seems short indeed. Whatever failures there have been in not modifying many of these defaulted mortgages, remedies for housing’s slow recovery ought not to center on creating bad incentives once again in mortgage underwriting.

Washington now apes the Bourbons of pre-revolutionary France. “They learned nothing and forgot nothing,” said Talleyrand, some forty-odd years after the catastrophe of the French Revolution. With ultimate policy discussions driven by electoral politics rather than sound economic analysis, it is truly remarkable that current-day academic macro economists continue to research the real causes of the Great Recession. Even if economists come to a widely accepted conclusion, it is highly doubtful that policy makers will care, much less alter government policies to prevent such debacles from again occurring. Plus ça change, plus c’est la même chose.

The Bernanke Twist

Today, the FOMC finally got around to initializing the “taper.” It reduced the purchase of mortgage related securities by five (5) billion dollars beginning in January 2014 and a like amount of Treasury securities. Purchases in January will drop to $35 billion of mortgage securities and $40 billion of long term Treasury securities, (a total of $75 billion) while the Fed’s balance sheet continues to grow by those amounts as principal repayments will also be re-invested and the policy of rolling over maturing Treasury securities is continued.

The Committee said that economic activity is expanding at a moderate pace and that there has been further improvement in labor market conditions. At the same time, there is no strong evidence of rising inflation or inflation expectations. Since inflation is still well below the Committee’s target of 2.0%, and unemployment at 7.0% is well above its target of 6.5%, there is no rush to raise the Federal Funds rate. In fact, based on the forecasts presented by the 17 members of the Committee, as measured inflation is well below what the Committee feels is appropriate, the Chairman indicated that the accommodative stance of monetary policy is likely to be continued well into 2015. The lengthening of forward guidance is a kind of Bernanke “Twist.”

The Twist

With the Funds rate at the zero bound, the usual tool of monetary policy (interest rate changes) is inoperative and that has given rise to Fed balance sheet expansion via these asset purchases and at the same time, a policy of forward guidance to markets that the Funds rate is unlikely to rise for a considerable period. Lessening the magnitude of asset purchase—and likely further drops in asset purchases in the forthcoming year—has created a need to re-assure debt markets that a return to normal, interest rate based monetary policy is a long way off. The Chairman stressed the dependency of this forward course on continuing improvements in macroeconomic data and at the same time allowed for a reversal of the “taper” if as yet unforeseen and untoward macroeconomic data begin to show up. Thus the magnitude of the taper and its future amounts is not set in stone. It is “data dependent.” In the Chairman and the Committee’s view, monetary policy is still quite accommodative, both from the point of view of continuing to add to the Fed’s balance sheet, but more importantly by the very size of that balance sheet that weighs down interest rate rises. The market seemed to accept these statements at face value, as there was very little upward drift at the longer end of the curve. The 10-year rate moved about 5 basis points, while the equity market boomed hugely. (S&P 500 up 1.66$%, Dow 30 up 1.84% and the NASDAQ -100 up 1.16%). In effect equity traders cheered then end of the “taper uncertainty.” The vote on the Committee for these policies was nearly unanimous, with the exception of Rosengren of the Boston Fed who felt the unemployment rate was “still elevated and well below the target.”

Fed Projections

The new Committee forecasts show improvement in the expected range of 2013 and 2014 growth rates, while the anticipated unemployment rates were lowered in each of the years stretching out to 2016. Expected inflation (as measured by the PCE index) was expected to fall slightly stabilizing at 1.7 to 2.0% in 2016. Core PCE was not expected to be much different (the lower end of the range was raised by 0.1% in 2014 (to 1.4) and again in 2016 (to 1.8). Each of the years 2013 through 2016 was lowered from the September projection.

BB’s Press Conference

As I watched his press conference, I was struck by his comfort and his mastery of the data, the policy debate and his complete ease in answering each of the questions. Bernanke is well known as a baseball fan. Today, he was definitely on his game.

The “twist” he has underscored is not written in stone and it is not a pair of handcuffs on the incoming Chairperson. Data dependency is still in play, however he noted that Janet Yellen was in concordance with the entire statement and the underlying measures that are reflected in the wording. Bernanke has one more meeting as Chairman, and if the data continue to improve (or at least not worsen), it is likely that more tapering will be voted in that meeting. What the future pace of tapering might be once Yellen assumes the Chair is speculative at this point. Furthermore, there will be new members of the Committee surely by February, probably including Stanley Fischer, the former Chairman of the Bank of Israel and Deputy Manager of the IMF. Fischer’s likely relevance is that he has reportedly commented that he is not terribly in favor of strong “forward guidance” as he finds that the predictive power of Central Banks is not sufficiently great, particularly at long intervals. What a Yellen-Fischer combination is likely to do to forward guidance and the pace of tapering will be the next uncertainty faced by equity and debt traders. Today, it was all cheering. Next year may be different

Perhaps the most interesting answer given by Bernanke in the press conference was in answer to the question of why it is with all the measures taken by the Fed that growth has not resumed its former long term tendency and even more important, that unemployment is still far in excess of recoveries in past recessions. Bernanke pointed out that first, fiscal policy has been part of the extreme headwinds, certainly over the past year and that other uncertainties such as the banking issues in Europe have not yet created the growth push of a normal recovery. He pointed out, for example, that in the prior recovery, State and Municipal employment rose about 600,000 while in this recovery, public employment was down some 400,000. A million less public jobs has made reducing the unemployment rate much more difficult. In his closing remarks, he reiterated the William Mcchesney Martin adage of the Fed being “independent within the Government,” reminding critical Congressmen that Congress writes the rules and the Fed is charged with carrying them out. Clearly, Bernanke meant to assuage some of the more vociferous advocates of “audit” and “control of the Fed” in saying that Congress certainly has the right to ask questions of the Fed and to set the ground rules for Fed targets. He did not get into the “audit the Fed” controversy but he clearly has still one more Hill to climb and surely hopes that it won’t be an ordeal

Inconsistently consistent: too much focus on the “taper”

Interest sensitive equities got spanked yesterday as a “good” growth report shook the equity and bond markets again. Another example of good news becoming bad news for investors and renewing an already enlarged focus on what the Fed will do the next time the FOMC meets. Markets have become inconsistent with common sense but in that inconsistency, there are guided by a Fed that is “inconsistently consistent.” Continue reading

Who’s the Fish: the Qwest for Truth

Joseph Nacchio, former CEO of Qwest, recent release from prison evokes memories of the various financial fiascos in the communications industry during the Enron Era.1 While current news seems focused on his remarkable physical condition achieved during his nearly four years in prison, there is also mention of Nacchio’s contention that the SEC’s case against him for securities fraud was motivated by his refusal to grant NSA access to Qwest phone records following the events of 9-11. The exposure of Prism, the NSA’s gigantic communications surveillance program, through revelations by defector Edward Snowden, has re-opened comment on why the SEC went after Nacchio in the first place. Nacchio was charged and convicted of insider trading following disclosure of some $52 million of sales of Qwest stock whose market value suddenly plunged after his sales. His defense at the time was that the government came after him when he refused NSA’s request for phone records.  Continue reading

The 5 year ordeal of the XL Pipeline

Five year anniversaries can be joyful or sad. It all depends upon what one is celebrating. Undoubtedly, “extreme greens” must be dancing as five years have gone by due to their efforts to prevent the creation of the XL pipeline extension. A sober consideration of this dubious achievement reflects well on the Administration’s effort to reward environmental lawyers for their resolute pursuit and personal economic benefit of ‘keeping the world cleaner.” The facts don’t support such a claim, but if you have already made up your mind on what the true goal of the effort might be, ‘don’t confuse the issue with the facts.”
Continue reading

Slow and Slower: Summers Withdraws

Summers Withdraws as Potential Fed Chairman: “politics” triumphs again

The forced withdrawal of Larry Summers from the short list to succeed outgoing Chairman Bernanke clouds the policy future. It also gives encouragement to the market that whoever is chosen to lead the current cat-herding cavil at the FED will not be able to abruptly turn off the spigot of current monetary ease. Markets that worry about the present but strongly discount the future should be calmed because a continuing rise in the interest rate on 10 year bond has seemingly been moved to the back burner. Continue reading