Well, the famed modeler from M.I.T. has finally admitted that he has been an avid reader of Notes From Underground and in the world of global macro finance, 2+2=5. The FOMC statement was a surrender to the work of Michael Woodford as was pre-released in a Janet Yellen speech a few weeks ago. The FED will give great credence to a 6.5% unemployment and a 2% inflation threshold, give or take a 0.5% discretionary prerogative. The 6.5% unemployment threshold is also subject to FED discretion for it seems to depend on whether or not the labor participation rate is increasing while the unemployment rate declines.
The FED chairman does not believe that the economy’s full employment rate is only 6.5% but only an indicator of enough possible strength in the economy to move the FED off its zero Interest rate policy (ZIRP). The 6.5% level provides the FED with a REACTION FUNCTION. Bernanke stills believes that the 5.2%-6.0% is the level of unemployment that the U.S. economy is capable of supporting. In moving to the 6.5% guidepost, the FED relinquished the “extended period” language and has now made its decisions DATA DEPENDENT–of course, with all decisions being based on conditionalities. See, the FED is now a global macro discretionary trader and has tossed aside the quants beloved black box.
The problem with this new mode of decision-making is that it POLITICIZES THE FED EVEN MORE. While I may not agree with all the decisions of Chairman Bernanke and believe that Donald Kohn would have been a better chairman, he has brought transparency to the FED that had been previously suffocating under the tutelage of Greenspan. The ability to use discretion in FED decision-making is a needed change from the rigor of academic theory and models, but it is also a dangerous tool in the hands of a chairman bent of political expediency.
In the press conference, Bernanke was asked why the FED moved to QE4 and will continue to buy $45 billion a month in Treasuries–in addition to the $40 billion in MBS. He noted that it was important to maintain the MOMENTUM OF CURRENT POLICY. It is important to stay aggressive, especially with fiscal policy being so uncertain. He in no uncertain terms reiterated that monetary policy has its limits and that fiscal policy makers must do their job. So, it is pedal to the floor on FED QE as the momentum must be secured.
The post-FED markets were PERPLEXING. Outside of the new QUALITATIVE approach to monetary policy, I saw little to think that the GOLD should not have rallied fifty dollars. Wednesday the GOLD struggled to rally at all and Thursday saw a $25 break and a new weekly low. The DOLLAR did weaken on the FOMC news and remained softer. More importantly, though, the GOLD/EURO and GOLD/SWISS are flirting with closing below the 200-day M.A. on the week. Friday’s action will be important for the GOLD. Of course the 200-day m.a. resides in the low 1660s so that might be the most important test of all. There is a great deal of chatter about the looming break in the U.S. bond market but with the FED looking to buy a TRILLION DOLLARS of new paper, I am a reluctant bear.
The short side of the U.S. Treasury market has been the pain trade of the last two years. (Sometimes not owning the crap is as good as being short.) The FED‘s destruction of the bond pricing mechanism makes it difficult to use the bonds as an economic barometer. The 10-YEAR U.S. note has an effective negative yield and yet they cannot break. One day they will but I will wait for the technicals to be my guide and live to fight another day. The FED can be more aggressive buying DEBT than I desire to be selling it. So I will practice QUALITATIVE DISCRETION.
I am putting in a chart showing the increase of Treasury holdings by the largest participants since January 2007. The FED‘s holdings of U.S. Treasuries, excluding MBS, has doubled. More importantly, the chart reflects that U.S. debt is not like Japan’s in that foreign based entities own a great deal … just a reminder of the perils that await the outcome of poor policy.
***Sunday, the elections take place in Japan and it is all but certain that the LDP will return to power under the leadership Shinzo Abe. It will be important as to how many seats the LDP will win outright for a strong LDP victory will mean that it will not need many coalition allies. Mr. Abe has made the BOJ‘s tight monetary policy a center piece of his campaign and with it the curtailment of BOJ independence. Since the onset of the election campaign and the rise of Mr. Abe’s lead in the polls, the YEN has been on a downward trend, having fallen from 77.25 YEN/DOLLAR to 83.50 YEN.
The YEN will be a part of Abe’s policy to creat inflation in Japan and end the period of deflation that continues to benefit Japanese bondholders. The JGB‘s have been the death trade for 18 years as global traders believed that the monetary policies of the BOJ would ignite inflation. The continued period of deflation has meant that even with very low interest rates for the last two decades savers in Japan have enjoyed positive real yields. Mr. Abe wants to end that and force money out of savings. I am linking to an election analysis on CNBC ASIAN SQUAWK by my son, Tobias Harris. He can provide far better analysis than I. Enjoy.
***Today the Swiss National Bank left its policy unchanged and maintained the EUR/CHF floor at 1.20. The Swiss france rallied as some traders thought the SNB was going to raise the intervention level on the EUR/CHF to 1.25. It didn’t come to fruition so short Swiss franc trades were covered but the investment world was warned by SNB Chairman Thomas Jordan that the Swiss authorities will do all they can to maintain their efforts to weaken the Swissie. The GOLD/SWISS cross is hovering at 200-day m.a.support so those looking to short Swiss francs on various crosses will have a close risk area to play against.