Notes From Underground: The Fed Steps Into the Light???

The release of the FOMC minutes today revealed that the FED plans to be more transparent as it will “publish forecasts of its own interest rates for years into the future.” Previous FED forecasts have proved to be very poor at predicting the path of the economy over the near term or yet for any longer period of time. On first read, this attempt at transparency ought to be labeled the VOLUME ENHANCEMENT FOR THE CME EURODOLLAR CURVE. FED prognostications will move the 3-5 year part of the curve all over the place and be very productive at increasing futures and options volume.

THIS BLOG IS ALWAYS FOR INCREASED TRANSPARENCY, but are FED SUMMARY of ECONOMIC PROJECTIONS (SEP) really shining more light onto FED policy making? As I am not of believer in the FED‘s DSGE MODELS, which have failed miserably in their predictive value, the outcome of the FED‘s efforts will certainly create more volatility.

A question in my mind is: WILL THIS NEW TRANSPARENCY MEAN A GREATER POLITICIZED FED AS THE SEP FORECASTS COULD SIGNIFICANTLY IMPACT THE ELECTION CYCLE? Also, as the FED has recently shown, the impact of the global economy can have a significant impact on policy making (SWAP LINES AND COORDINATED RATE CUTS), thus rendering the views of FOMC participants to sudden change and create greater havoc. Is there a point where too much transparency becomes self-defeating?

***The EQUITY MARKETS staged a very solid first day rally as higher oil prices boosted energy stocks and the lack of any headlines from Europe helped to stabilize equity and debt markets. The precious metals also found a reason to rally as it appears that REDEMPTION FORCED LIQUIDATION HAS RUN ITS COURSE FOR THE TIME BEING.

The Globe and Mail, a Canadian newspaper, had an interesting article in which it reported that Greeks and Italians were moving money out of banks and stashing it in home safe deposit boxes and moving the EUROS into German and other safer jurisdiction banks. As we discussed a few weeks ago, this is a contemporary form of GRESHAM’S LAW, as savers in the GIIPS are hoarding the GOOD MONEY (EUROS), as they fear the imposition of exchange controls to prevent the outflow of money.

There are many analysts who believe the current incipient recession in Europe will lead to GOLD sales, but if FOREIGN EXCHANGE CONTROLS BECOME PREVALENT IN EUROPE,THEN GOLD WILL BECOME A HAVEN OF VALUE PRESERVATION. Thus, we will continue to monitor the cross border bank flows within Europe as a precursor to a GOLD RALLY. The Spanish banks have not noted a large outflow yet  but as the news from Spain worsens it will be a high probability that Spanish savers seek shelter in other regional banks. Over the weekend there was news from the new Spanish government that the budget deficit was larger than previously stated, 8% vs 6%. As we have seen in Greece, Portugal and Ireland, AUSTERITY BUDGETS AND HIGHER TAXES CREATE THE ADVERSE FEEDBACK LOOP that undermines all economic projections.

***In a positive piece of news, the corporate tax rate in Canada falls this year to 25%–the lowest amongst the G-7. This has been a 5-year process so the impact will not be as severe as if it was a sudden event. The low tax impact should lead to Canada being quicker to raise rates to stem any increased economic stimulus from the lower tax regime. Strong banks, a huge natural resource sector and very low corporate taxes. Canada is far more than just a risk on commodity play, but as always advised: Do your TECHNICALS and let the market tell you when the time is right. Fundamentals, we don’t need no stinking fundamentals!

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3 Responses to “Notes From Underground: The Fed Steps Into the Light???”

  1. john brady Says:

    As today’s trade may be slower, we thought we would take a closer look at yesterday’s Dec 13 FOMC Minutes, and the key sentence from the Minutes may have been:

    “With regard to forward guidance to be included in the statement to be released following the meeting, several members noted that the reference to mid-2013 might need to be adjusted before long”

    The politics of the season are beginning to heat up.

    There has been and will be a focus on the evolving Fed communication policy, which aims to add clarity and transparency to Fed policy. We are not as surprised as others, as Chairman Bernanke suggested this very idea early and often in his nomination testimony of November 15, 2005. The story here is NOT the increased transparency of policy; rather it is the timing of the move towards increased “transparency”.

    On Friday, December 23 2011 the Bureau of Economic Analysis released Personal Consumption and Expenditures data for November. Buried in the minutia of the data was a very disturbing trend that FOMC policymakers did not directly reference in yesterday’s meeting, but was most likely discussed:

    Personal Savings Rate:
    Q3, 2010: +5.6%
    Q4, 2010: +5.2%
    Q1, 2011: +5.0%
    Q2, 2011: +4.8%
    Q3, 2011: +3.9%

    In considering these numbers, we tend to think that equities have been mostly flat over the last year, while home prices have failed to steady in a meaningful way and maintain a modest downside bias. Household wealth is continuing to decline in sync with the savings rate. Moreover, we think a more important sentence from yesterday’s minutes is:

    “Revised estimates indicated that households’ real disposable income declined in the second and third quarters, and the net wealth of households decreased in the third quarter (of 2011)”.

    So, in short–and we haven’t touched on the slowing in non-defense capital goods orders (excluding aircraft) nor on the risks posed by the ongoing European financial crisis–deflationary pressures are intensifying here domestically and the FOMC is getting very nervous. Strong Q4 economic growth/consumption will most likely not be sustainable, given an already declining savings rate, declining disposable income, and declining household net worth. Recall that YOY inflation measures are set to drop shortly as high monthly readings from early 2011 are scheduled to drop out of the data set. So what is the Fed to do, especially with the zero-bound already achieved and three injections of quantitative easing already used to debate-able success?

    …Change Communication strategy!?!? It is not overly-tricky and rather convenient in a year where the political climate is due to get very dirty and ugly. Fiscal policy debate regarding payroll tax cut extensions will begin a-new in the coming weeks, while Dr. Bernanke has already been singled out by Republican primary candidates as performing his job poorly. With the savings rate (savers are punished with zero rates! Einstein’s power of compound interest is null-and-void!) dropping, with real incomes dropping, with total household net worth dropping, and with an election 10 months away, something has to be–and will be–done. That’s a Nixon legacy, and better to do something sooner-rather-than-later as the election nears.

    Individual members of the FOMC will soon issue their own individual forecasts for rate policy, and thus–in changing “communication policy”, the politics of monetary policy are going to shift away from the Fed Chairman and create lots of debate and noise over whose policy forecast is more/less accurate. The noise of public forecasts will shade and cover the Fed’s worst nightmare coming true: intensifying deflationary pressures addressed through politically-charged and additional quantitative easing. Thus, the new key members of the FOMC as it specifically regards monetary policy in 2012 are going to be Vice-Chairwoman Janet Yellen AND her successor at the San Francisco Federal Reserve John Williams, a noted dove and supporter of additional qe. The Fed set the table at the December 13th meeting.

    Why Yellen and Williams? Bernanke is already too well-known and now needs to avoid the limelight in the political arena. Dudley is radio-active to the 99% (Goldman Sachs, NY Fed, etc…). Most importantly, most voters don’t know of Janet Yellen or John Williams by name or appearance. Their communications and forecasts will represent and drive the deliberative (dovish) majority of the FOMC in 2012. No disrespect meant towards Sandra Pianalto, Dennis Lockhart, and Jeffrey Lacker, but John William’s September 23, 2011 speech in Zurich, Switzerland and the October 3, 2011 FRBSF Economic Letter suggests that this specific topic has already been researched pretty thoroughly by the SF Fed:

    There was additional hints of this policy at the SFFRB conference of February of 2011, though this paper is quite technical (Paper enclosed).

    “The expectations channel is crucial for the effectiveness of optimal forward guidance policy. If the public has an imperfect understanding of the central bank’s intended policy path, then forward guidance may not work as well as adverstised. Therefore, a key challenge for forward guidance is communicating the intended policy path to the public.”

    In short, Dr. Williams may have emerged as the Fed’s lead-person on communication and forecast policy, specifically with Fed policy already at the zero-bound. Funny enough, Mr. Williams is scheduled to speak at an Economic Forecast Breakfast in Vancouver, Washington on Tuesday, January 10, following the December employment data and ahead of the 2-day FOMC meeting Jan 24/25. Forecasting may be more art than science, but with the science of recent economic data and with domestic deflationary headwinds set to perhaps intensify as the Eurozone crisis intensifies and the US Dollar heads higher (see enclosed), we think the QE table is set. Dr. Williams and Yellen are the key policymakers this year. John Brady and Todd Colvin

  2. yra Says:

    John and Todd—a very good post as you cover a great deal of ground and the insights on the San Francisco Fed are informative.

  3. Chris Chacona Says:

    Ditto. For more on the near-term policy context, see Vince Reinhart’s contribution to the discussion on CNBC yesterday.


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