Notes From Underground: JACKSON HOLE is RUNNING ON EMPTY

The Bernanke speech did not surprise readers of NOTES FROM UNDERGROUND as Bernanke did not promise any new stimulus plan but spent most of the speech recalling the successes of the FED’S extraordinary efforts to stimulate the economy and prevent a disastorous deflationary period from gaining traction in a debt-ladened financial system. The initial market response was a selloff in the precious metals as the ALGOS reacted to a no new stimulus headline with, “risk off” and after reading that the headlines were cursory and misleading, reversed and the GOLD AND OTHER RISK ON ASSETS WENT INTO FULL RALLY MODE.

Parsing the speech for a few key words does not always result in any type of PERSPECTIVE–UPON FURTHER REVIEW! As the day in Jackson Hole commenced, various speeches and stories revealed far more insight into POSSIBLE FED ACTION. Professor Michael Woodford delivered a 96-page paper on “ACCOMMODATION at the Interest-Rate Lower Bound”.This is a very in-depth, highly academic paper which covers a great deal of discussion about the use of communication to help aid the policy intent of central banks.

I warn my readers to familarize yourselves with these terms: FORWARD GUIDANCE, CONDITIONAL COMMITMENT, NOMINAL GDP, FUNDING FOR LENDING SCHEME (FLS) and even the 7/3 COMMITMENT as put forward by Chicago Fed President Charles Evans. I bring these to you attention so as to make us aware of the next FOMC statement and its language. Will the FED begin to target NOMINAL GDP, a level based on inflation and real GDP as a target to reach before it begins to raise rates and remove stimulus.

By listing some CONDITIONAL COMMITMENT to a predetermined target, the FED would provide FORWARD GUIDANCE SO MARKETS WOULD BE AWARE OF WHEN THE FED WOULD MOVE AND NOT JUST RELY ON THE REGULARLY RELEASED DATA. If the NOMINAL GDP TARGET WAS 5%, then the markets would know that would be the trigger point for the FED to change its policy stance.

As Woodford states: “And a statement that is viewed as expressing A COMMITMENT, that by virtue of its having been stated should at least to some extent constrain future policy decisions, should be most informative of all.” Fed President Charles Evans has placed a type of FED CONDITIONAL COMMITMENT on the table, the 7/3 COMMITMENT, which would be a FORWARD GUIDANCE that the FED would maintain its present policy of aggressive stimulus until there was 7% unemployment or 3% inflation, or maybe both. There are, of course, many who oppose such types of communications but as WOODFORD lays it out traders must be on the alert that the FED begins to invoke such types of tools in the FOMC statements.

***The WSJ had an article on Saturday by Michael S.Derby, “Fed’s Bullard: Negative Interest on Reserves Is A Stimulus Option.” In a Friday interview from Jackson Hole, St.Louis Fed President James Bullard said he saw benefits in going to negative rates on excess reserves held at the FED (IOER). It is important to understand why Bullard is changing his view and is willing to go to a negative rate from the present +25 basis points on IOER. President Bullard said, “you could go to minus 25 or minus 50 basis points. That gives it more punch….” Bullard notes that because other central banks have tried it the FED could probably do so as well.


Read this carefully for it represents the FED’S dismay about the vote that took place last week at the SEC, where the MONEY MARKET FUNDS were able to beat back a reform effort favored by Mary Schapiro, the U.S. Treasury and most importantly, THE FED. There seems to be anger that the break the buck philosophy of the MONEY FUNDS places systemic risk in the system, thus the regulators want MONEY FUND investors to bear some of the financial risk and maintain a capital buffer to mitigate against potential runs. The MULTI-TRILLION MONEY FUND firms want to maintain the staus quo and fear any buffer would cause money to flee and seek alternative instruments.

The political clout of the MONEY FUNDS won the vote at the SEC but from Bullard’s comments it seems that the FED may enter the battle with a plan of its own. It now seems possible that the FED will go NEGATIVE ON IOER as a lever against the staid practices of MONEY MARKET FUNDS as BULLARD IS SAYING THAT THIS IS A POSSIBILITY. If so, it seems that the U.S. 2-YEAR NOTE MAY BE THE INSTRUMENT IN WHICH TO PLAY. The support of Bullard’s comments will probably come from the FSOC (Financial Stability Oversight Council) chaired by Secretary Geithner.

***The talk of the markets beyond Jackson Hole has been the weakness in recent Chinese economic data. From manufacturing indices to IRON ORE prices, the world is now concerned that the Chinese economy is slowing and will have a huge negative impact on global growth. Industrial metals have been under downward pressure as the Chinese cut back on raw materials as Chinese exports slow. The Chinese domestic economy has not matured enough to pick up the slack so all of that previous capital development is creating massive overproduction, which is leading to inventory buildup as well downward pressure on all types of manufactured goods. The problems in China are being sharply felt in Australia as mining companies are being dowmgraded as raw material prices fall.

Last month I warned that the Reserve Bank of Australia (RBA) made a critical error by not cutting rates.I argued that the FLATTENING of the Aussie YIELD CURVE was sending a message to the Aussies that problems were developing, and, given that the 2/10 curve remains fairly flat and the shorter end of the curve is in fact inverted, the RBA needs to cut rates. Tonight at 11:30 p.m. CST, the RBA will announce its decision–rates are presently at 3.5%. The Aussie buinesses are complaining about the relative strength of the AUSSIE DOLLAR SO A CUT OF AT LEAST 50 BASIS POINTS IS CALLED FOR. More importantly will be what Governor Stevens has to say about the Chinese and European economies.bFor what it is worth, I SAY CUT THE RATES GOVERNOR STEVENS.

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6 Responses to “Notes From Underground: JACKSON HOLE is RUNNING ON EMPTY”

  1. rohrintl Says:

    Hi Yra-
    Yeah, I put out some info on the holiday as well, because it IS very important to see the ex-US weakness. Kudos on highlighting the western Pacific Rim weakness that is a natural adjunct to Europe not recovering anytime soon.

    When rates remain high and a currency weakens anyway, it is a solid indication the central bank has missed the degree of incipient weakness that is about to expand into recessionary tendencies. What is amazing to me (or maybe not so much) is that seasoned China hands like Roach and Rutledge and others have that saw the generational change coming 20 years ago are now blindered in their lack of understanding that the next generational change is upon us:

    China’s transformation into more of a consumerist society will benefit all manner of global tendencies in the long run, but it is definitely a short term drag on psychology and economics.

    So thanks again for the excellent (as always) overarching perspective into what is likely two very pivotal weeks for the trends in most asset classes… and for the Jackson Brown quip re: Jackson Hole.

    Have a great holiday-

  2. asherz Says:

    If you weaken a $3 Trillion+ money market fund industry,where would the typical holder run with the safety he requires? Especially if we have negative rates.

  3. yra harris Says:

    Asherz—that is going to be the question going forward–but I wanted to discuss the fact that Bullard,a “known” hawk was putting it out there and I found that interesting and also be aware that the banks best friend Sec. Geithner is the heas of FSOC–so you tell me where the money is going to go–and the IOER does not have to stay negative for long

  4. hawaiilaw Says:

    Yra & Asherz – It’s going to 2 places – equities (where the Fed wants it to go) and gold (anathema to the fed)
    — I think the gold backed bond is inevitable

  5. hawaiilaw Says:

    — Forgot to add: Yra, your blog is second to none, and we have St Sinclair to thank for it

  6. yra harris Says:

    hawaiilaw–thanks for the support and the input.Much of what I learned from an early age about the practice of theory and markets came from having access to James Sinclair and of course discussions with his father,Bert,who was a living library like the rings in the TIME MACHINE

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