February 11, 2008
Poole: Best bet is that we will not have a recession
Via Reuters:
ST. LOUIS (Reuters) - The U.S. appears likely to avoid an economic slowdown but the chances of a recession have risen, St. Louis Federal Reserve Bank President William Poole said on Monday.
"I think the best bet is that we will not have a recession," he said in response to questions after a speech to the St. Louis chapter of the National Association for Business Economics.
However, Poole later told reporters, "There is no question that the odds (of recession) are higher than they used to be."
...
"So far we're standing with very sticky shoes on that slippery slope," he said. "We do watch it very closely; there's no question that there's a risk."
Poole said the housing market continues to be a problem, but based on his readings of retail and auto sales data, consumer spending is flat but is not crashing.
One glimmer of hope is that while recessions are typically characterized by large business inventory overhangs, stocks are currently lean.
But Reuters may have buried the lede.
In his prepared speech, Poole said efforts to provide guidance on the likely direction of interest-rate policy often can sow more confusion than clarity.
"I have concluded that an ... attempt to provide forward guidance in the policy statement causes more communications difficulties than it solves," Poole said. "A key reason is that the economy is subject to more shocks and reversals than one might think."
Those shocks require the central bank to change interest rates more frequently that he would have thought likely before he arrived at the regional Fed bank 10 years ago, he said.
Posted by William Polley at 11:45 PM | Comments (0) | TrackBack
December 22, 2007
Mankiw: Let the Fed do its job
Greg Mankiw writes in the New York Times today:
The question on the minds of many in Congress and in the White House is this: What they should be doing now to keep the economy on track? The right answer: absolutely nothing.
This advice isn’t easy for politicians to follow. Because economic downturns mean fewer jobs and falling incomes, they are painful for many families. Voters can confuse inaction with nonchalance and send incumbents packing. But just as patients should avoid doctors who recommend radical surgery for every ailment, voters should be wary of politicians eager to treat every economic ill. Sometimes, bed rest and wait-and-see are the best we can do.
Indeed it is true that the incumbent party does poorly, as Mankiw shows on his blog today (via Statistical Modeling).
Thus, Mankiw has a point, and later on in the article when he puts more faith in the Fed's ability to cope with the business cycle than Congress and the White House, I would also agree to a great extent. Whether the Fed is able to stave off a recession remains to be seen. If indeed a recession is to begin this quarter or the next (I wouldn't bet an awful lot of money on it, but it is a non-trivial probability), then what the Fed did in December or what they do in January will matter little. Likewise, if the economy rebounds in 2008 it probably wasn't the extra quarter point this month that saved us. Iacta alea est.
Posted by William Polley at 04:35 PM | Comments (3) | TrackBack
December 17, 2007
Wall St. Journal interviews Charles Plosser
The Real Time Economics Blog conducts a Q&A with the president of the Philadelphia Fed. Among other things, Plosser says,
It’s a mistake to rely on the slowdown for much disinflationary effect.
However, he was in agreement with the recent 25 basis point cut, given the changes in the economy since October. Read the whole thing. A short article is also in the Journal.
Posted by William Polley at 10:21 PM | Comments (0) | TrackBack
December 11, 2007
Some wanted more
And so it is 25 basis points and not 50. Link to statement
The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/4 percent.
Incoming information suggests that economic growth is slowing, reflecting the intensification of the housing correction and some softening in business and consumer spending. Moreover, strains in financial markets have increased in recent weeks. Today’s action, combined with the policy actions taken earlier, should help promote moderate growth over time.
Readings on core inflation have improved modestly this year, but elevated energy and commodity prices, among other factors, may put upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
Recent developments, including the deterioration in financial market conditions, have increased the uncertainty surrounding the outlook for economic growth and inflation. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; and Kevin M. Warsh. Voting against was Eric S. Rosengren, who preferred to lower the target for the federal funds rate by 50 basis points at this meeting.
I am giving three final exams today (and am finishing up one of them now), so this has to be brief. Wall Street was clearly not impressed by this statement. The reasons are pretty straightforward. They were hoping for 50 basis points. (In your dreams, Wall Street.) So there was some obligatory pouting about that. But also the statement acknowledges the weakness but promises nothing more. The last paragraph (before the vote) is telling. The Fed is pointing to increased uncertainty. This is a classic instance of the committee wanting to buy a little flexibility. (We have discussed this before though I don't have time right now to find a link to the discussion.) In other words, they do not want this series of cuts to turn into anything resembling a "measured pace." They want to be able to say, "We just don't know right now."
I have to go start exam number three, so I will leave you with the best quote I have seen about the action so far. From CNN/Money.
"The Fed is not going to bail out the market. Time will heal these wounds. People don't want to hear that but it's the real world," said Rich Berg, chief executive officer of Performance Trust Capital Partners, a Chicago-based bond trading firm.
Indeed.
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December 06, 2007
Bank of England cuts; ECB holds steady
From the NY Times:
FRANKFURT, Dec. 6 — The European Central Bank, caught between fears of rising inflation and subsiding economic growth, walked a middle ground today, leaving interest rates unchanged.
But across the channel, the Bank of England opted to take action, cutting its key rate for the first time in two years, by a quarter-point, to 5.5 percent. The bank said the credit squeeze in the United States had curtailed loans for households and businesses, denting Britain’s growth prospects.
Apparently the ECB was not of one mind on their decision....
In a rare departure from his usual discretion about the bank’s deliberations, Mr. Trichet disclosed that some bankers on the 19-member governing council had argued for raising rates.
Meanwhile, the probability of a 50 basis point ease increased from 31% to 35% (reaching a high of 37%) as measured by the binary options contracts on the Chicago Board of Trade.
Posted by William Polley at 03:29 PM | Comments (0) | TrackBack
December 05, 2007
A little good news
Productivity is up. (BLS press release)
The Bureau of Labor Statistics of the U.S. Department of Labor today reported revised productivity data—as measured by output per hour of all persons—for the third quarter of 2007. The seasonally adjusted annual rates of productivity growth in the third quarter were:
6.7 percent in the business sector and
6.3 percent in the nonfarm business sector.
In both sectors, changes in productivity are higher than the preliminary estimates published November 7, and represent the largest productivity gains since the third quarter of 2003. The upward revisions to productivity resulted from upward revisions to output—which grew 5.7 percent in both sectors—and small downward revisions to hours, which fell 1.0 percent in the business sector and 0.6 percent in the nonfarm business sector in the third quarter.
Also see the Wall St. Journal.
Does this change anything going into the FOMC meeting? In my estimation, no.
Posted by William Polley at 12:16 PM | Comments (1) | TrackBack
Martin Feldstein's two pronged approach
Also in the Wall Street Journal today is a piece by Martin Feldstein. Here are some excerpts.
Further interest-rate cuts can reduce the risk of recession and increase output and employment in 2008 and 2009. The current 4.5% fed-funds rate is essentially neutral -- not low enough to stimulate growth and not high enough to reduce inflation. Although there are risks that the rise in oil prices and the falling dollar will raise the inflation rate, the greater potential damage of an economic downturn calls for a more stimulative policy. The Fed should reduce the fed-funds rate at its December meeting and continue cutting toward 3% in 2008, unless there is a clear sign of an economic improvement.
Because of current credit market conditions, there is a risk that interest rate cuts will not be as effective in stimulating the economy as they were in the past. The current credit crunch reflects not only a lack of liquidity, but also a lack of confidence in the creditworthiness of counterparties and in the accuracy of asset prices. This problem is now being compounded by the banks' loss of capital as they recognize past losses, and by their need to use large amounts of the remaining capital to support existing off-balance-sheet credits that have to be shifted to their balance sheets. All of this implies that lower interest rates may not raise lending and economic activity to the same extent that they did in the past.
The latter paragraph is a good follow up to Greg Ip's piece. In old fashioned Keynesian terms, what we've got here by this reckoning, is the basis for a liquidity trap. Later in the article, Feldstein adds the second part of his strategy.
What's really needed is a fiscal stimulus, enacted now and triggered to take effect if the economy deteriorates substantially in 2008. There are many possible forms of stimulus, including a uniform tax rebate per taxpayer or a percentage reduction in each taxpayer's liability. There are also a variety of possible triggering events. The most suitable of these would be a three-month cumulative decline in payroll employment. The fiscal stimulus would automatically end when employment began to rise or when it reached its pre-downturn level.
Enacting such a conditional stimulus would have two desirable effects. First, it would immediately boost the confidence of households and businesses since they would know that a significant slowdown would be met immediately by a substantial fiscal stimulus. Second, if there is a decline of employment (and therefore of output and incomes), a fiscal stimulus would begin without the usual delays of the legislative process.
You're probably familiar with the term "automatic stabilizers". Well this takes the concept to the next level. A tax cut conditional on economic data--that's an interesting suggestion. Unfortunately, the temporary nature of the cuts would tend to reduce their impact. Anyway, read on.
Even if the Fed decides that it should not cut rates further at the present time, it would not raise rates to offset the stimulus effect of the fiscal change. From the Fed's point of view, the tax cuts can provide a desirable short-run stimulus without the inflationary impact that would result from a lower interest rate and an increase in the stock of money.
Dust off your trusty old IS-LM model and let the fun begin.
Some reliance now on a fiscal stimulus rather than easier money would also take pressure off the exchange-rate adjustment. While further declines of the dollar are necessary to shrink the massive U.S. trade deficit, continued rapid declines might lead to counterproductive retaliatory actions by some of our trading partners.
Add a dash of Mundell-Fleming.
The excessive asset-price increases caused by some past monetary expansions -- especially the induced rise in the prices of real estate -- provide a further reason to use fiscal as well as monetary policy. By cutting the fed-funds rate to just 1% in 2003 and promising that it would be raised only slowly, the Fed contributed to the sharp rise in house prices and the market's current weakness. A mixed strategy that included a prospective fiscal stimulus would have reduced the Fed's perceived need for a sustained negative real fed-funds rate, and would therefore have produced a more balanced expansion of demand.
But didn't we cut taxes in 2001 and 2003? Yes, however those cuts were aimed in large measure at increasing long run growth--the success of which is a fair topic of debate. That's not to say that the short-run stimulative effect was nil. But the question is: would a temporary tax cut with a similar order of magnitude to the 2001 and 2003 cuts have any more stimulative effect? Or would people just save it?
Mark Thoma also mentions the permanent income hypothesis, but doesn't mention the 2001 and 2003 tax cuts. Interestingly, a lot of prominent economists opposed the 2003 tax cut because they thought it should be temporary (contrary to Thoma) in order to provide stimulus without threatening the long term budget outlook and that it should include a spending component (in agreement with Thoma).
I think temporary tax cuts won't work very well (in agreement with Thoma) and I have my doubts about temporary spending increases (more bridges to nowhere?), contrary to Thoma. So where does that leave us?
With a lower funds rate in 2008, that's where.
Posted by William Polley at 12:04 AM | Comments (1) | TrackBack
December 04, 2007
Greg Ip on the upcoming Fed meeting
Greg Ip has a knack for giving you tomorrow's news today when it comes to the Fed. Here's what he's got for us today. (Wall St. Journal)
Futures markets expect at least a quarter-percentage-point rate cut and see a two-thirds probability of a half-point cut. Fed officials will likely consider the larger cut, but some might find it hard to justify when just a few weeks ago they thought they were finished cutting rates.
Some analysts say the Fed is more likely to deliver a quarter-point rate cut and drop from its statement last month's characterization of risks of weaker growth and higher inflation as equally balanced. That would implicitly leave the door open to additional easing, without leading investors to presume further cuts were coming.
Analysts also believe the Fed could improve the functioning of financial markets with either an additional cut in the discount rate -- at which the Fed lends directly to banks -- or by lengthening the terms of such loans.
And later in the article, this key insight which, although it has been expressed, probably hasn't been talked about as much as it should yet:
Fed officials' main concern isn't the current economy, though recent data have been on "the soft side," as Chairman Ben Bernanke said last week. Rather, it's that banks and other lenders, having already tightened mortgage-lending terms, will do the same with loans to small and medium-size businesses as well as credit cards and other consumer credit. Fed officials don't believe banks' reluctance to lend will go away after Dec. 31. And Mr. Bernanke warned that could "impose additional restraint on activity in housing markets and in other credit-sensitive sectors."
Subprime gets all the attention. Mortgage lending is the big story. A general recession is a real concern. But the economy can certainly ride out the subprime mess. The housing market will recover even if it takes many months. The real threat that could potentially cause a serious recession is if other credit markets besides the mortgage market start to seize up because of a generalized lack of liquidity. The Fed is simply taking out some insurance that this won't happen. But there's even so, there are no guarantees... which brings us to our next installment (see next post).
Posted by William Polley at 11:38 PM | Comments (0) | TrackBack
December 03, 2007
San Francisco Fed's Yellen still sees downside risk
Here's the speech.
Here are some excerpts:
To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level. However, for the next few quarters, there are signs that growth may come in somewhat lower than I had previously thought likely. For example, some of the risks that I worried about in my earlier forecast have materialized—the turmoil in financial markets has not subsided as much as I had hoped, and some data on personal consumption have come in weaker than expected. I continue to see the growth risks as skewed to the downside in part because increased perceptions of downside economic risk may induce greater caution by lenders, households, and firms.
...
It seems most likely that core PCE price inflation will edge down to around 1¾ percent over the next few years under appropriate policy and the gap between total and core PCE inflation will diminish substantially. Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. This view is predicated on continued well-anchored inflation expectations. It also assumes the emergence of a slight amount of slack in the labor market, as well as the ebbing of the upward effects of movements in energy and commodity prices. However, we do still face some inflation risks, mainly due to faster increases in unit labor costs, the depreciation of the dollar, and the continuing upside surprises in energy prices. Moreover, labor markets have continued to surprise on the strong side. All of these factors will need to be watched carefully going forward.
...
In line with the forecast-based policy I’ve described, the Committee’s decisions reflected a forward-looking and preemptive approach. In particular, I supported putting a substantial easing in place so as not to fall “behind the curve.” Given the long lags between policy actions and their impact on the economy, and the possibility that economic downturns can be difficult to reverse once they take hold, an approach that was more gradual and reactive than this would have created unnecessary economic risks.
Since the October FOMC meeting, financial conditions have deteriorated, and we have seen some unexpected softening in the economic data. These developments necessitate some rethinking of my growth forecast, and have highlighted the downside skew in the risks to that forecast. On the inflation front, I continue to expect core consumer prices to rise at a pace that is broadly consistent with price stability, although there are some notable upside risks that bear careful watching and consideration. Additional data bearing on the outlook will become available before the FOMC’s meeting next week, and this information must also be factored into an assessment of the economy’s prospects.
I'm with Tim Duy. Ignore the hawks. FYI, the Chicago Board of Trade binary options shows the probability of a cut at 93%.
Posted by William Polley at 05:00 PM | Comments (0) | TrackBack
November 30, 2007
Bernanke: "Headwinds" for the consumer likely in months ahead
Chairman Bernanke spoke last night. Here's the full text. Here's the part that made everyone take notice.
With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.
Posted by William Polley at 08:38 AM | Comments (0) | TrackBack
November 29, 2007
Market expectations for a rate cut become solidified
It's been a while since we have looked at the fed binary options from the Chicago Board of Trade. And there was some significant movement today too.
Implied probability of at least a 25 bp cut is now at around 87% (call option with 95500 strike price closed at 87, up 9 from yesterday's close).
Implied probability of at least a 50 bp cut is now at around 30% (call option with 95750 strike price closed at 30, up 10 from yesterday's close).
Payoffs are based on the target fed funds rate at the end of December. Hence these take into account the possibility of an intermeeting cut.
It's impossible to point to one factor as being the prime mover here. There's Donald Kohn's speech where he says,
Another consequence of operating under a high degree of uncertainty is that, more than usually, the potential actions the Federal Reserve discusses have the character of "buying insurance" or managing risk--that is, weighing the possibility of especially adverse outcomes. The nature of financial market upsets is that they substantially increase the risk of such especially adverse outcomes while possibly having limited effects on the most likely path for the economy.
See also, Frederic Mishkin from earlier this month.
We also have the steady drum beat of negative housing news along with a jump in jobless claims. Not even a GDP revision can overcome that. (Of course, the GDP revision is not fooling anyone into revising their forward looking forecast. Barry Ritholtz calls the revision "fanciful".)
But two Fed officials have expressed a clear preference to hold rates where they are. One votes at the next meeting. The other will be a voting member next year. (Reuters)
CHICAGO (Reuters) - Two Federal Reserve Bank officials hinted strongly on Tuesday that they would not support an interest rate cut in December, contending that the Fed has provided enough insurance against financial turmoil and would risk opening the door to higher inflation.
The comments from Chicago Fed President Charles Evans and Philadelphia Fed President Charles Plosser put the central bank at odds with financial markets that are anticipating a series of rate cuts over the next few months.
...
But Evans and Plosser, while acknowledging risks to the economy, suggested that further cuts to the federal funds rate, the bank's most powerful policy tool, might not be the right solution to the credit market's problems.
...
"In some circumstances, lowering interest rates may prolong the painful process of price discovery," he said in a speech to the Rochester University Simon Graduate School of Business.
I think I may use that quote in my classes next week.
The beat goes on.
Posted by William Polley at 12:06 PM | Comments (0) | TrackBack
November 08, 2007
Bernanke speaks on the economic outlook
Today is a teaching day for me, so I don't have much time. But I am currently listening to Bernanke answering questions from the Joint Economic Committee. Here is a link to his testimony. Not much about inflation in there.
As I write this and listen to the Q and A, Ron Paul is apoplectic, as you might imagine.
In other news, the ECB and the Bank of England leave interest rates where they are.
I'm giving a test in a couple hours. One of the concepts we have been discussing is the relationship of the value of the dollar to the interest rates at home and abroad. Nothing like being able to pull a question right out of the headlines.
Posted by William Polley at 10:19 AM | Comments (0) | TrackBack
November 06, 2007
Plosser tells it like it is
From the NY Times
In an unusually blunt interview, the president of the Federal Reserve Bank of Philadelphia said he already expected growth to slow to an annual pace of 1.5 percent or less. But he said he would not support another rate cut unless the slowdown appeared to be even sharper than that.
Read the whole thing.
Posted by William Polley at 05:10 PM | Comments (2) | TrackBack
Catching up... and my trip to the Fed yesterday
I figure I've logged about 1600 miles of driving in the last 11 days. That cuts into the time available for blogging. Things should improve now for a while at least.
Yesterday, I was in Chicago with my students competing in the 7th District College Fed Challenge. Three time defending national champion Northwestern University won again. Although the University of Chicago certainly gave them a run for their money. We faced U of C in the first round and thus didn't advance. Even so, the value of the program as a learning experience for our students is tremendous.
Fredric Mishkin spoke yesterday about the risk management approach to monetary policy decisions. This was the basis for the lead off question in the final round Q and A session at the Fed Challenge. By the way, all of the final round teams (in addition to our team), were unanimously in favor of holding rates constant at this point in time. The competition is real-time. Therefore having it so soon after the last meeting does sort of predispose one to holding steady. However, there was a lot of discussion and debate by all the teams about what the outlook is going forward.
As for that outlook, Tim Duy is concerned.
...One has to imagine that the Fed must be feeling a little uneasy about pulling the trigger on another 25bp last Wednesday given Friday’s employment report. Still, they likely take comfort in the belief that they drew a line in the sand with the statement, declaring a balanced risk outlook.
But can they stick to that line during a scary four months? Can they look through to that period of “moderate growth” that they keep predicting? I would like to believe they are ready to stick to their guns, but recent history is not on my side.
...
Can the Fed resist that pressure to keep cutting even if they are confident that the medium term risks are really balanced? If the “risk management” faction at the Fed continues to hold power, it seems like more rates cuts are likely, especially if there is any hint of further softening in employment or investment. That is what recent history tells us.
Standing in the way of additional cuts, however, is these new-found inflation concerns that appeared in the last statement. Declining core-inflation has been cited as a justification for Fed easing based upon decreasing estimates of the neutral Fed funds rate. I would only like to suggest that the recent history of core-PCE is not all that comforting. Looking a three-month inflation trends on an annualized basis:
I detect something of an upward trend in the past four months, on the order of 50bp – perhaps it is too early to be lowering estimates of the neutral rate? Personally, I wouldn’t break out the champagne on the inflation story just yet. It appears, however, that Fed Chairman Ben Bernanke and Governor Frederick Mishkin – the power couple in the “risk management” regime – already popped the cork.
The chart is from Duy's post at Economist's View.
This is precisely a point that was made by my students as well as most of the other teams at the Fed Challenge yesterday. This is a concern going forward. There is a very real risk that any further easing could have nasty repercussions for intermediate to long term inflation expectations. And if the Fed is going to be facing a real inflation problem in a year or two, when the economy is still trying to right itself from the subprime debacle, that's not going to be good for growth either.
See also this article by Bloomberg's John Berry.
Posted by William Polley at 11:01 AM | Comments (1) | TrackBack
October 31, 2007
A final thought on today's Fed move
Here's one paragraph from the Wall Street Journal article on the move.
Stocks and bonds sold off on the news. The Dow Jones Industrial Average ,up over 80 points before the Fed's afternoon announcement, initially fell into negative territory. Long-term bond prices, which move in the opposite direction of yields, fell. The statement appears to sharply reduce the odds the Fed will cut rates again at its December meeting, as markets had expected.
Please excuse my shouting for just a moment.... GOOD! Maybe they'll take it to heart this time.
There, now I feel better.
Comments are coming in fast and furious to the Journal's Real Time Economics blog. They are overwhelmingly harsh. Personally, I don't share that harsh assessment that this was the wrong thing to do. I don't think this was a decision that they wanted to make. Certainly it is not a decision that they thought they would have to make a few weeks ago. If they could go back and do a couple things differently, they might be tempted. Given the way things evolved, they did the best they could, came up with a better statement, and maybe learned a thing or two. Could be worse.
Posted by William Polley at 01:58 PM | Comments (2) | TrackBack
CNBC: Fed cuts target fed funds rate and discount rate by 25 basis points
Ok, first of all, the Fed needs to upgrade its web server to handle the extra load if they are going to give us any more days like this. I think all the people checking in at 1:15 (Central) might have brought down the server. I'm getting nothing right now.
Here's the CNBC story. The link to the statement will have to wait until their server catches its breath.
UPDATE: And here it is... FOMC Statement
The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.
Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.
Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.
The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.
Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Donald L. Kohn; Randall S. Kroszner; Frederic S. Mishkin; William Poole; Eric S. Rosengren; and Kevin M. Warsh. Voting against was Thomas M. Hoenig, who preferred no change in the federal funds rate at this meeting.
My first impression is that it is a good statement... better than the last. In the first paragraph (not counting the opening sentence), I see a reiteration that this move, with September's, should help forestall adverse effects from the housing trouble. In other words, I see this as telling the market, "You didn't get it last time but let's try this again. We're serious." Ok, maybe that could have been stronger. But there is an additional sentence about the inflation risks. That's good. There is a statement that the balance of risks is roughly equal. That is the key. That is a much stronger way of saying that the predisposition is going to be towards doing nothing unless something really serious pushes them off of that stance. It is a lot stronger than the previous statement. Though it will be ruthlessly parsed word by word in the next few hours, my initial read is that this satisfies me.
Hoenig dissented. Poole did not. Some might be surprised, but I was not. Poole's interviews lately have been pretty balanced. He has been upfront about recognizing the risk from financial instability. Hoenig, on the other hand, didn't get as much attention. But I do remember this item...
TULSA, Oklahoma (Reuters) - Federal Reserve Bank of Kansas City President Thomas Hoenig on Wednesday said he was keeping an open mind about the future direction of interest rates but was on alert for fallout from financial market woes.
"Wait and see," he cautioned an audience at a dinner hosted by the Kansas City Fed.
That was from October 17. I kept that story in my feed reader for some reason... as if I thought I might want to reference it someday.
And as I said before, the fact that someone dissented and asked for no change does a lot for making this a credible statement that says that they are done unless something at least a standard deviation out of the ordinary occurs.
Well, that was an interesting couple of days. Let's do it again in about 6 weeks... with a little less drama, maybe?
Posted by William Polley at 01:16 PM | Comments (0) | TrackBack
Does 3.9% GDP growth change anything?
In the very short run (like, say, the next couple hours), no. Wall St. Journal story on GDP here. The stock market, quite predictably, rallied a bit. However, it has not moved anyone seriously off of their expectations of a 25 b.p. rate cut. So, if your immediate thought was that this might buy the Fed a way out, I have to say that I don't think it's any easier. In a perfect world, expectations might have been more balanced coming into today and then this data could have tipped the balance towards doing nothing. I might wish that was the world we live in, but it's not. Felix Salmon has more.
On the fundamental question of what the Fed should do--taking everything, including expectations, into account--I'm left with the opinion that while it would be a courageous statement of principle to do nothing (and part of me really wishes they could), I think it might be too risky given the somewhat fragile state of the market. I'm really holding my nose as I say that because I don't like the idea of the Fed being pushed into doing something. But in some sense you also have to play the hand you are dealt...or the hand you dealt yourself... or something.
Commenter Kevin writes:
I think Ben's Fed has really tried to stay away from any commitments about the path of future policy moves. So I think your suggestion that they say that this will be the last cut is a nonstarter. However, what I do expect would be more guidance about the conditions for any changes - which may include taking back the rate cuts (imagine that!).
First, a clarification. When I made reference to them saying that this would be the last cut, I was using some verbal shorthand at the end of a long post (in a three part series!) Of course they will not say it in so many words. They can "say" it in their assessment of the risks to growth and inflation. It's easy to come up with some wording that would say that they are going to have a "neutral bias" (though that language is itself somewhat passé). Whether one could make that language credible is another matter.
So then what about some guidance about the conditions for any changes? Not yet, not in any formal way. That could potentially end up being part of the new communication strategy that the Fed is discussing. But not yet. And they are certainly not going to say anything today about when these cuts are going to be taken back. Not a chance. Personally, I'd like to see that guidance too. I think one could make a credible case that if 4th quarter GDP growth is above X and if average monthly job growth stays above Y and if core PCE stays below Z, then they could raise the funds rate in January or March. But they certainly aren't going to tell us X, Y, and Z (or whatever other indicators would come into play). And I really don't think you're even going to get much of a hint yet. I think the best we can hope for is a strongly worded statement that growth is stronger than anticipated, that the housing problems have not yet spilled over into the broader economy, and that the magnitude of that spillover may be less than anticipated. Furthermore, firms are getting squeezed by higher input prices. While that has not yet passed through to final goods prices, the weaker dollar is going to put more pressure on firms to raise prices. (Except that the Fed will not talk about the weaker dollar, but you get the idea.) Make it so we expect that at least 25 basis points will be taken back if this strength continues. That way, if the 4th quarter ends up being only slightly weaker, they could still get by with holding steady in December and January.
It's almost time.
Posted by William Polley at 12:45 PM | Comments (1) | TrackBack
October 30, 2007
Countdown to FOMC
I've got a full plate tomorrow, so I may not be able to post in the morning. I am going to try to arrange it to be around the computer at 1:15 (Central), though I may step out to watch CNBC for the actual announcement. So here are my thoughts after a long day of kicking this around, watching the markets, and reading the commentary.
25 b.p. still seems like what we will see. Greg Ip's column didn't push the market very much toward any real expectation that they will do nothing. But it did wring out any hope of getting 50 b.p. If that was the intent, it worked. If it helps the market get a little better perspective going forward (looking ahead to December), then it's a good thing.
Tonight I find myself thinking about tomorrow's GDP numbers and wondering about inflation. I find myself compelled to say that I really hope that the Fed can create an expectation that there will be no cut in December and stick to it. 4.5% may not be exactly neutral, but it's close. Close enough to be a good vantage point to see where we go from here.
I'm sure it is frustrating for Fed officials to have a market that responds to every bit of news as a potential tipping point, but that's the environment we live in right now. They can manage it once they recognize how sensitive everyone is to a hint of economic weakness and how entrenched the sentiment is that the Fed will rescue them. This is Mr. Bernanke's chance to establish his approach to managing market expectations. The statement tomorrow will tell all.
Enough kibitzing. It's their move.
Posted by William Polley at 09:53 PM | Comments (0) | TrackBack
November fed funds still looking for a cut
As of 9:30 (Chicago time) November fed funds were trading at 95.485 after starting the day at 95.495. Greg Ip's article may have spooked Wall Street, but at the corner of Jackson and LaSalle the expectation is, at this hour, still a 25 b.p. cut.
Click the image for the full size version. Source: Chicago Board of Trade (10 minute delayed quotes)
Electronic trading in fed funds continues overnight. You can see that when Ip's article hit the internet, the reaction was immediate but short-lived.
It should be an interesting 27 hours or so.
Posted by William Polley at 09:41 AM | Comments (3) | TrackBack
October 29, 2007
Could the Fed hold rates constant? (Part III)
One more thing, that deserves mention. Don't think that it hasn't crossed my mind that this piece by Greg Ip may (probably?) reflect some internal Fed talk that they want to get out to the public. Reuters even picked up the story in one of those rare journalism twists where the story itself is the story.
The article by Greg Ip, the Journal's Fed watcher who is known for sometimes reflecting the views of senior central bankers, said policymakers view this week's decision as a choice between a quarter-point cut to 4.5 percent and not moving at all.
Seems like there are (at least) two possibilities. Either this is supposed to prepare the market for no cut at all, or it is meant to totally disabuse the market of any thought of a 50 b.p. cut before such speculation gets out of control.
It could be a little of both. A cut is not a sure thing. It's probably still the most likely and least risky option. But I'm prepared to be wrong. I just can't imagine a unanimous vote to hold steady, whereas I can imagine a unanimous (perhaps one dissenting) vote for 25 b.p. And I wonder about the signal that would be sent if a vote to hold steady was not unanimous. Whereas if a hawkish member dissents from the consensus to cut, I think that's easier for the market to swallow (a better indicator that they figure that they are slightly below a neutral funds rate), and it would still be consistent with the tone of Ip's article. Comments?
Posted by William Polley at 11:32 PM | Comments (2) | TrackBack
Could the Fed hold rates constant? (Part II)
Tim Duy makes his stand.
And So It Begins, by Tim Duy: The Fed begins a two-day meeting today, with market participants widely expecting a rate cut. I am mentally prepared to be on the wrong side of this call, joining the lonely few, but I just can’t tease another rate cut out of the incoming data.
In my mind, the argument for a rate cut hinges on one crucial assumption – that the market is expecting a rate cut, and the Fed will not want to disappoint....
Agreed. He also says...
If the Fed fails to ease, so the story goes, they will be blamed for failure to communicate effectively. After all, given their push for transparency, shouldn’t they make an effort to send a signal when the markets are headed in the wrong direction? The problem with this view is that Fed Chairman Ben Bernanke does not believe it is his job to lead markets around by the nose like his predecessor. I think under the new regime, the Fed expects their comments to be taken at face value. And I think they are pretty effectively communicating their view on the economy: Outside of housing, there is minimal spillover, and whatever spillover exists is completely expected....
I do see Tim's point about Mr. Bernanke. But by the same token, Mr. Bernanke has to realize how his comments would be interpreted (in the October 15 speech to which Duy provides a link). If he didn't like it, there was time for him or others to refine the message.
If the Fed decides they are unwilling to defy the market, or that “risk management” requires additional rate cuts, I would have to conclude that regardless of what the statement says, that one must expect a series of multiple rate cuts. They will be responding to the deteriorating housing market, and I simply expect no stabilization in that market in the near future (don’t get me wrong – I am not a pie-in-the-sky optimist).
I know, and I've voiced my concern about this. But Tim is suggesting here that there is no way for them to issue a credible statement that really indicates that they are done. Obviously the September statement wasn't it. But I think it's possible to craft such a statement.
Bottom Line: I believe the Fed intended to take a pass in October with the 50bp rate cut. I believe market participants were correctly reading the data until they got caught up in the risk management story. I think the Fed has been explaining past actions, not future policy. For that, you need to look at their forecast. On the basis on the data alone, the Fed is already so far in front of the curve it is hard to justify another cut at this point. I absolutely do not expect the Fed to cut 50bp.
I also believe that they intended to hold rates constant now when they made their decision in September, and it is possible (likely?) that the risk management story got overblown. But I'm less convinced that they were explaining their past actions. I don't see them as being "far in front of the curve". I see them as wanting to get just a little bit below neutral. Given that potential growth may be slowing and inflation is mostly contained, they are probably not quite at neutral yet. I could accept another 25 b.p. as getting us close to where they want to be to end the year, or just a bit below. I think they would prefer to end the year at 4.5% as opposed to roiling the markets this week by throwing them a curveball.
Cut now, and make it clear that it's an early Christmas present and that they're not getting any more in December. Make it clear that at 4.5%, policy is neutral to slightly accommodative. I think they could sell that.
Tim and I agree on a couple things. A 50 b.p. cut is pretty much out of the question. He says he is mentally prepared to be wrong. So am I. But the more I look at the minutes of the last meeting, the Fedspeak, the continued uncertainty, and the general unease about growth prospects in the 3 to 9 month period ahead, the more I think that the decision to cut carries a bit less risk than the decision not to cut.
A thought occurs to me. The fact that we're having this last minute discussion about the possibility of no cut would, I believe, make it more credible for the Fed to announce that this week's cut (if there is one) is the last for a while.
Posted by William Polley at 10:30 PM | Comments (1) | TrackBack
Could the Fed hold rates constant?
Greg Ip, as always, has some of the keenest insight. In tomorrow's Wall St. Journal, he has a piece called "Why Rate Cut Isn't a Sure Thing."
Both courses of action have risks. Perhaps the biggest is that the market's certainty that rates will be cut creates a burden on the Fed to deliver. Ordinarily, meeting market expectations isn't a goal in itself for the Fed.
But the current environment is more fragile than usual, and thus the consequences of disappointing the market are potentially more damaging. Against that, the Fed will have to weigh the risk that a cut will stoke inflationary psychology.
I've been going back and forth on this in my head for the last week. My head would like to see a bold move to keep rates constant at this meeting and re-evaluate in December. My gut thinks that Mr. Bernanke will err on the side of caution. That we're even having this discussion indicates that there is much work to be done on the communication channels between the Fed and the market.
The bottom line for me is still that the Fedspeak leading up to the quiet period before the meeting was pointing to more downside risks. I took that to mean that they are leaning toward easing.
So let's think about how a "no cut" scenario plays out. The only way they can stand pat is to give a statement that opens the door to future cuts should intermeeting data turn sour. Given that GDP and payroll data is just around the corner and a long time from that data to the next meeting, I think there is a risk that holding steady now could potentially cause expectations of future cuts to get built into the market really soon after this meeting. I don't think they would find that to be optimal. Furthermore, I doubt that they could get a unanimous vote to hold steady. Again, the expectations of future cuts are sure to be built in from day one.
But if they cut on Wednesday and made a statement that credibly states that they are done for a while, I think that would be easier for the market to digest, and probably lead to a better result in the long run. Then in the intermeeting period they could clarify that they really are done unless things turn sour--and speak frankly about what it would take. They would have to state that they think that they are (75 b.p. lower than this summer) now ahead of the curve, that they need to stay vigilant with regard to long term inflation expectations, and that they have revised their growth forecast upward.
Door number 2 seems the likely choice. But it's not a sure thing.
C'mon folks! What do you think?
Posted by William Polley at 09:58 PM | Comments (0) | TrackBack
Thoughts on the Fed
Today's best article on the upcoming Fed meeting is in the Financial Times. Read and understand.
The Federal Reserve is likely to cut interest rates by a quarter-point to 4.5 per cent when its two-day policy meeting concludes on Wednesday. But the debate among Fed policymakers will be more finely balanced than is suggested by the odds in the futures market – in which a rate cut is seen as a virtual certainty.
According to anecdotal reports, there is some resistance among Fed insiders to the notion of a guaranteed rate cut. Many would have preferred to go into the meeting with market odds more evenly balanced, which would give the central bank greater latitude to make its determination without risking market turmoil.
It seems safe to say the Fed was not expecting to be in this situation when it cut rates by half a point in September. As Don Kohn, vice-chairman, explained shortly afterward, the Fed believed that by cutting rates more than expected it would get ahead of the curve.
The initial 50-basis-point cut was “a not unreasonable first approximation of what might be required to keep the economy on a sustainable path”, Mr Kohn said.
Indeed. Yet, some of the data that has come out since September has been worse than expected, particularly in the housing market. No need to rehash all of that here. We all know what has been going on. A sober assessment of the risks to the economy would have to include an increased recession risk since August and even since September. On that basis, it's hard to argue against a rate cut.
And yet, as an October cut has become more certain, it has also increased the likelihood that the market will expect future cuts. To feed into that belief would be a regrettable mistake. So how does the Fed tiptoe around this minefield?
First, they need to recognize that if there is going to be a housing induced recession, there is little that they can do about it short of refueling the housing boom, which is not an option. The cost of doing nothing may be slow growth for a couple of years. The cost of doing something may be a resurgence of inflation after a couple of years.
Higher oil prices and a lower dollar pose long term risks for inflation if the Fed is not careful. If the funds rate is below 4% in early 2008, I would become concerned about the inflation outlook going forward. They have to be very careful not to let expectations of inflation rise as that would just lead to more painful readjustments later.
The members of the FOMC know all of this very well, and I don't think they want a repeat of the last rate cutting cycle which went too deep for too long. And yet they will be tempted to yield to the siren's song. Ironically, it is less a matter of political pressure (as some say existed in the 1970s that led to inflation then) and more a matter of market pressure. Wall Street, not Pennsylvania Avenue, is addicted to the rate cuts. Even the scent of it in the air sends the Dow up these days. And as long as the Fed is worried about disappointing those who have made their bets at the Chicago Board of Trade, there is going to be a temptation to take the cuts too far. It's "measured pace" all over again but in the other direction. Remember how frustrated I was about that situation? I'm just as frustrated now. As wonderful as the fed funds futures market is, I'm sure that the inhabitants of the Eccles Building occasionally curse at it under their breath. That's why a communication policy revision is seriously in order.
Some kind of policy rule would really help. Because right now you have a situation where the market is guessing the Fed's next move and the Fed doesn't want to disappoint the market. Since market prognosticators are pretty bad at calling turning points, this makes it hard for the Fed to change direction. It's a setup for trouble, and is one of the better arguments for a policy rule such as an inflation target.
But since we don't have such a policy rule now, we will have to be content with simply wanting the Fed to make a statement that they are done for now, unless they aren't. As the FT article concludes:
More likely, policymakers will seek to balance a rate cut with a statement that tempers expectations of many more cuts to come. They will again hope they are done. But with economic uncertainty still high, they will want to leave open the option to cut again if necessary at the next meeting.
And you know what that means. We'll be having this same discussion again in a few weeks, unless they decide to send a signal that they are not beholden to the futures market and keep rates steady. As much as I might like the signal that it would send, it is an option that is not without risk. Perhaps a dissenting vote in favor of no cut could send the same message in a less risky way. I'm not convinced that the statement alone, no matter how strongly worded, would send the same message.
Marc Shivers thinks it will be 25 basis points as well. He bases this prediction off of the recent speeches by Fed officials. I've been reading those as well and I concur. Standing pat is a somewhat attractive option, and while a longshot, it seems more likely than 50 b.p. But ultimately, either extreme is too risky as it could roil the markets more than they want. If I were on the committee I would probably vote for no cut as long as I knew I would be in the minority. They will compromise on 25 b.p. and hope that they are done. (But I'd like them to prove me wrong by issuing a statement that really has some teeth.)
Posted by William Polley at 11:48 AM | Comments (0) | TrackBack
Fed meeting this week
I'll post my thoughts on the FOMC meeting later today. For now, read Greg Ip's piece in the Wall Street Journal.
Posted by William Polley at 12:53 AM | Comments (0) | TrackBack
October 25, 2007
Fed increasing transparency
Grep Ip writes in the Wall Street Journal:
WASHINGTON -- Federal Reserve officials are nearing consensus on several steps to make their deliberations more transparent to the public, but are likely to defer one of Chairman Ben Bernanke's longstanding goals: an explicit inflation target.
The centerpiece of their new communications steps would be the release of economic forecasts of policy makers four times a year, instead of the current two times, with additional detail and background, according to people familiar with the matter. Moreover, the horizon for those forecasts would be extended to three years from two.
Trying to set a target without really setting a target?
While the idea of setting an inflation target hasn't been shelved, officials say it needs more discussion. Meanwhile, they see the longer forecast horizon as an interim step with many of the benefits of an inflation target. The public could assume the Fed expects to achieve its desired inflation rate in three years and thus a third-year forecast amounts to a target. The forecast approach sidesteps the biggest problems with an official number: the misgivings some officials still have with a target, potential political fallout and the difficulty of agreeing on the right number.
...
At his nomination hearing in 2005, Mr. Bernanke restated his preference for a target while promising "extensive discussion and consultation" and "no precipitate steps." After he became chairman, he began making greater use of the FOMC forecasts to explain Fed policy. He also appointed Fed Vice Chairman Donald Kohn, like Mr. Greenspan a skeptic of targets, to head a subcommittee on communications. Mr. Kohn has shown signs of warming to the notion. In September, he said in a speech he was "relatively more persuaded" that targets help anchor the public's expectations of inflation.
Mr. Kohn is an important figure on the Board. If he comes around, there is a chance. But a big obstacle still remains at the other end of Constitution Avenue, and the committee is rightly cautious.
The FOMC as a whole is still not ready to take the step. One concern is that Congress, having taken a more populist turn since Democrats took power in 2006, could perceive a target as subordinating the Fed's responsibility for employment, despite Mr. Bernanke's insistence to the contrary. Another is that officials don't think the current system is broken.
No, it's not broken, but nor was it broken when many of the other steps toward transparency were taken. In principle, a target would certainly help to anchor expectations. And as a practical matter, a three year forecast might work as a reasonable proxy for an operational target even if nothing is written in stone. Additional releases of forecasts are surely welcome to any observers of the Fed out there.
I look forward to more of this.
Posted by William Polley at 09:55 AM | Comments (0) | TrackBack
October 05, 2007
111,000 Jobs in September: Good enough for Fed to hold?
Good, not great. That's how I'd sum up today's employment report.
Employment rose in September, and the unemployment rate was essentially unchanged at 4.7 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Nonfarm payroll employment rose by 110,000 following increases of 93,000 in July and 89,000 in August (as revised). In September, health care, food services, and professional and technical services continued to add jobs, while employment trended down in manufacturing and construction. Average hourly earnings rose by 7 cents, or 0.4 percent.
The unemployment rate actually climbed just a bit, but a 0.1% move in either direction is within the statistical margin. That said, it was 4.5% this summer, so that gives fuel to the argument that things have marginally deteriorated. Spencer was correct with his hypothesis that August numbers would be revised upward due to a fluke of timing in the data collection period. The last 3 months have clocked in at just under 100,000 per month on average.
That's no great shakes, but it's not recessionary yet. Opinions differ as to just how much job growth is needed per month to keep up with population growth. For a long time 150,000 was the number tossed around. Demographic changes have likely lowered that number, though probably not under 100,000. In casual conversation these days, I settle on around 125,000 and admit to uncertainty. In that respect, the recent numbers are good, but not great.
Given the current uncertainty about whether we are on the cusp of a recession, however, the numbers take on greater importance. Everyone wants to know whether this will move the Fed. No doubt this is a data point in favor of a less aggressive move, or perhaps no move at all. The Chicago Board of Trade binary options indicate that the probability of some kind of cut in October dropped from 56% to 41%. It's still pretty much a coin toss, but the bias of the coin shifted just a tad.
Then there was this speech today by Don Kohn. (h/t Calculated Risk) Here are a couple of salient points.
Many people had expected the Federal Reserve to follow a gradual path of rate reductions in response to financial market developments--say, 25 basis points in September and another 25 basis points in October. Such a path would be in keeping with how we have often approached our policy choices, as it has the advantage of allowing us to calibrate our policy as we see how the economic situation is evolving and responding to earlier policy moves. However, given the circumstances at the time of the September FOMC meeting, there were strong arguments in favor of the larger action of a 50 basis point decrease in the federal funds rate. For one thing, it seemed that a decrease of that size could well be necessary to promote moderate growth. We had been holding the federal funds rate at 5-1/4 percent, well above the expected rate of inflation, in part to compensate for what had been very narrow yield spreads and readily available credit. We did not know how quickly markets would recover, the extent to which credit terms and standards would be tightened, or precisely how households and businesses would respond to recent or forthcoming financial developments. But, pending further evidence, a 50 basis point easing was not an unreasonable first approximation of what might be required to keep the economy on a sustainable growth path.
In addition, I thought that economic performance would be better served by the Federal Reserve taking its chances on responding too much, or too rapidly, to the turmoil in financial markets rather than acting too little, or too slowly. Sluggish or inadequate easing risked a weaker real economy that might cause lenders to pull back even more, leading to a deteriorating situation that could prove difficult to reverse. With the news on inflation relatively favorable of late and with inflation expectations seemingly well anchored, I believed that we would be able to offset the cut in the federal funds rate--if it turned out to be larger than needed--in time to preserve price stability.
And what will become the headline for this speech...
We will need to be nimble in adjusting policy to promote growth and price stability.
That would seem to suggest a Fed that was ready to move decisively with an opening gambit of 50 basis points just in case all of it was needed. That doesn't mean that the next move will be that aggressive. Furthermore, they're ready to take it back if prices jump.
But right now inflation still seems contained. The CPI is up just 2% in the last year (that's the headline number, not core) and the most recent reading was actually a slight decrease. If the economy softens, it will keep the pressure off. But if not... then it pays to be nimble.
There is still a very large amount of sentiment for continued rate cuts, and today's employment number, while not entirely dismal, will probably not diminish that sentiment among those who hold most tightly to it. For those on the margin, it may be enough to urge them to wait. If the rest of the month's data turns out to be consistent with the labor data, then they may put off a cut until December. It seems to me right now that a further cut in October is speculative--an insurance policy in case the housing problems spill over into the broader economy. The more insurance they take, the greater the likelihood that they find themselves needing to reverse course in 2008.
For now, for my money, it's still a tossup.
In related action, PGL discusses the labor force participation rate and employment/population ratio. He mentions our discussion from way back. I'll say it again. The long run trends are for lower LFPR and E/P as the baby boomers retire. But that's not what we're seeing here. I raised the point then and repeat it now as a caution to not necessarily expect the "optimal" ratios today (and in years to come) to equal those of the late '90s. However, the declines over the last year (like the increases in the previous year) are of a more high frequency nature. PGL is correct to raise the issue. The decline in these numbers since December is indicative of some potential problems below the surface that deserve more investigation. More on that later.
Posted by William Polley at 03:38 PM | Comments (2) | TrackBack
October 02, 2007
Phelps on whether the Fed can prevent a recession
This just came in my inbox.
Sep. 27 (Bloomberg) -- Edmund Phelps, winner of the 2006 Nobel Prize for economics and a professor at Columbia University, talks with Bloomberg's Tom Keene from New York about limitations of U.S. Federal Reserve monetary policy, the role of central banks in preventing economic slowdown and risk facing the U.S. economy. (Source: Bloomberg)
I'll have to listen later. Time for class.
Posted by William Polley at 12:14 PM | Comments (0) | TrackBack
September 20, 2007
Just when I was almost convinced we're heading for recession, I see something like this
Activity in the region’s manufacturing sector picked up in September, according to firms polled for this month’s Business Outlook Survey. Indexes for general activity, new orders, and shipments increased, reflecting continued underlying growth. Firms continued to report a rise in prices for inputs, but price increases for finished manufactured goods were not widespread. On balance, the forecast for growth over the next six months has not diminished appreciably, even though, according to responses to special questions this month, over one-quarter of the firms said they are scaling back employment and capital spending plans because of the recent deterioration in the construction industry and uncertainty in financial markets.
...
Respondents continue to report higher prices for inputs this month. The prices paid index increased eight points, after edging lower in the previous three months. Thirty percent of the firms reported higher input prices; 7 percent reported lower input prices.
Less than 10% of firms surveyed expected a substantial decline in employment or capital spending as a result of recent developments.
I think I just heard a bond price drop. The 10 year yield stands at 4.63% and climbing.
Posted by William Polley at 12:08 PM | Comments (1) | TrackBack
Bernanke speaks (and other assorted news)
Chairman Bernanke gave testimony to Congress on the subprime situation today. Read it on the Fed's newly redesigned website. The only mention of monetary policy is at the end, and it includes nothing new, only some quotes from the press release Tuesday.
In other related news, initial jobless claims were down, reaching their lowest level since July 28. This suggests that the employment report may have been a blip. Employment is somewhat of a lagging indicator, so don't get too worked up and thinking that the threat is over. More trouble could still be to come. Nevertheless, we'll take good news when we can get it. The Index of Leading Indicators, however, was down slightly.
Meanwhile, a certain former Fed chairman is enjoying his time in the spotlight. It is hard to get used to seeing Alan Greenspan all over the place talking to the media candidly, but get used to it we will. (Reuters)
Asked in an interview on Bloomberg television whether the Fed's half-percentage-point rate cut on Tuesday had lowered the chances of a recession, Greenspan said: "I think so, but remember that we still have a problem out there, which is a large overhang of unsold newly constructed homes."
...
Greenspan said the chances for a recession in the United States were still "somewhat more" than 1 out of 3, despite the cut in the Fed's overnight federal funds rate to 4.75 percent, but cautioned it was hard to be more precise.
"We are often wrong but never in doubt on too many issues," he said.
Indeed.
We're watching history unfold here, folks. The unwinding of the subprime mess is without precedent. But the monetary policy action has parallels in the past. Will this episode be more like 1998 (heading of systemic risk, short lived easing and a return to previous levels in a year) or like 2001 (the beginning of a series of cuts and the re-inflation of a bubble)?
To apply the wisdom of Greenspan, someone who doesn't have some doubt stands a good chance of being wrong.
Posted by William Polley at 09:48 AM | Comments (2) | TrackBack
Quite a day (Part II)
And so 50 basis points it shall be. Where do we go from here?
This was one of the most difficult Fed decisions to predict in recent memory. It was a bold move the Fed, and there are those who would disagree with it. A lot of us (Tim Duy and Barry Ritholtz, for example), myself included, were surprised. The market called it a toss-up. To my way of thinking, a 50 basis point move was a considerably less likely. I didn't put a probability on it, but I probably wouldn't have gone much over 20 or 30%. At least I was right that the move in the discount rate would match the cut in the funds rate and that they would not cut the discount any by an additional amount. But all that is ancient history now.
Perhaps a Q&A format would be a good way to organize my comments here. The questions are the things I've been hearing in the last day or so, and the answers are just my thoughts. You are free to agree or disagree (and comment).
Question 1: Did this move cost the Fed credibility?
Not as much as some think, but they did cash in some chips. The true cost to their credibility (or lack of cost) will not be known until we see the effect on inflation. The Fedspeak was not unambiguously pointing this way, but this wasn't totally out of the blue. Even those of us who were hoping for (and expecting) only 25 basis points were not shocked. We knew it was a possibility. Yet those of us who were hoping for 25 basis points were, I think, doing so on the basis that a larger rate cut isn't going to do as much good at preventing a spillover of the housing mess into the broader economy as it could do long term harm in the campaign against inflation. The Wall Street Journal is worried about their credibility too.
When I see a speech where a Fed official says this...
I believe disruptions in financial markets can be addressed using the tools available to the Federal Reserve without necessarily having to make a shift in the overall direction of monetary policy. A change in monetary policy would be required if the outlook for the economy changes in a way that is inconsistent with the Fed’s goals of price stability and maximum sustainable economic growth.
... it doesn't exactly scream out 50 basis points. So a 25 basis point cut certainly would have cost them less in the immediate run. Now, they are smart people, and they must have realized that. Yet they voted (unanimously, I might add) to do it anyway. That leads to the next question.
Question 2: Do they see something that we don't?
I anticipated this question back on the 10th. Clearly one of the risks to doing a 50 basis point cut is that people will think that it's worse out there than they thought (or worse than it is). But the answer to the question is, I believe, "no". To the extent that they see something we don't it could be that the inflation picture looks better than we thought. PPI and CPI data from the last couple days would support that claim. It's certainly too early to declare victory, but they may be hearing things from their contacts in the business community that allow them to take this position. But as for fighting a recession, if it has already begun, which it may well have, this isn't going to make much difference. So no, I don't think the see anything negative about growth that we don't already know.
Question 3: Is this "one-and-done"?
That is, did they figure that they could avoid the loss of credibility by making a larger cut now and then stop. Yeah, that's the question you want to have answered. Sorry to disappoint, but I can't say for sure. The fed funds futures market doesn't think so, however. They're looking for another 25, maybe 50 basis points, by the end of the year as December futures are implying a rate of 4.4%. If they want the market to believe that this is "one-and-done", they'll have to come out and say it because the message will not get through otherwise. If forced to make a guess right now, I would predict 25 basis points in October and December, but it's early and that's subject to change.
The problem I see is that in order for the Fed to hold steady, they are going to have to be able to state that the risk of a spillover from the housing market into the broader economy has materially diminished. I don't see how they'll be able to make that claim. A month from now the housing picture will not change much from what it is now.
Question 4: What are the downsides to this decision?
You saw the stock market reaction, right? You saw the double digit percentage gains among the homebuilders, right? You saw the price of gold, right? You saw this, right? Now, I don't always agree with Dean Baker, but in this post he is spot on 100%.
A bit of history would have been useful to include in this context. As some articles noted, this cut bears a resemblance to the Fed's 0.5 percentage point cut in January of 2001 at an unscheduled emergency meeting. That cut also led to a very enthusiastic response from Wall Street. The Dow rose 2.8 percent following that cut and the Nasdaq jumped by a record 14.2 percent. In reporting on the significance of the cut, the NYT quoted Bruce Steinberg, chief economist at Merrill Lynch: "there's a simple message, the Fed will do whatever it takes to keep the U.S. economy from going down the tubes.''
Mr. Steinberg may have been right about the Fed's intentions. It did continue to cut interest rates, lowering the federal funds rate by a total of 5.5 percentage points to 1.0 percent, the lowest rate since the mid-fifties. However, this rate cutting did not prevent the economy from falling into a recession. It began to lose jobs just a month after the January rate cut. In spite of the Fed's aggresive rate cutting,the economy remained so weak that it took four full years to once again reach the employment levels of February 2001.
The market may celebrate now, but this is fleeting. The punch bowl has been refilled, but you may have just made more work for the clean-up crew. Listen to Tim Duy, for example:
The Fed statement did claim that “some inflation risks remain,” but the concern rings hollow in the wake of a 50bp cut. Oil and gold gained on the news, while the Greenback sunk to a record low against the Euro before recovering. Were these, like the equity surge on Wall Street, just knee-jerk reactions? To some extent yes, but traders tend to get the direction right even if the magnitude is initially wrong.
He's not in the one-and-done camp either.
James Hamilton has this to say:
But the really interesting thing is what happened at the longer end of the yield curve. The ten-year nominal yield actually increased, which is in contrast to the usual historical pattern for long yields to move, albeit less dramatically, in tandem with the short. Taken together with today's fall in the 10-year inflation-adjusted Treasury yield, the bond market seems to view the Fed as having surrendered some on its long-run inflation goals.
Right. From the gallery in the CBOT, we watched it happen as the 10 year numbers went red and you just wanted to have a moment of silence for the passing of low inflation expectations. You teach this stuff for years, saying "this is what can happen..." and then it does.
I have to admit that the market reaction troubled me a bit. They didn't get the message. Or they got the wrong message. Or worse...they got it just right.
Question 5: Do I have anything good to say?
Yes. I am happy that the language of the statement does not appear to lock the Fed into any particular decision in October. True, I think they will continue to ease. However, I don't get that from the statement as much as I get it from the present circumstances. They will have a chance to move expectations, but the window will be open for only a short time. If they want to hold steady in October, they better get out there soon and communicate that, or it will be too late.
In fact, I think that the language of the statement was about as good as it gets for something like this. It was different, and fresh. We needed that.
The bottom line is that we'll have plenty to talk about for the next few weeks.
Posted by William Polley at 01:57 AM | Comments (2) | TrackBack
September 19, 2007
Quite a day (Part I)
I intended to post last night, but lack of sleep got the better of me. Anyway, the reason that I was away from the computer yesterday is that two other economics faculty and I took a group of econ majors, graduate students, and other interested folks up to the Chicago Board of Trade yesterday to watch what happened on the floor when the Fed announcement came out. Astute readers will recall this post from a few weeks ago:
Note to self: WIU economics faculty and students usually make a trip up to Chicago to see the Board of Trade every year. I am one of the faculty who works on scheduling and arranging the trip. I must do what I can to see if we can get up there on an FOMC day this fall.
The blog is great for keeping some of those notes to self in writing so they can be remembered and acted upon.
Let me also say that