First, as I read the FOMC statement, it was painfully obvious that the impact of the Michael Woodford piece found willing adherents in the bowels of the Board of Governors of the Federal Reserve. The FED’s language: “IF THE OUTLOOK FOR THE LABOR MARKET DOES NOT IMPROVE SUBSTANTIALLY, the committee will continue its purchases of agency mortgage-backed securities …” Further, in a direct BOW to Woodford: “The committee expects that a HIGHLY ACCOMMODATIVE STANCE OF MONETARY POLICY WILL REMAIN APPROPRIATE FOR A CONSIDERABLE TIME AFTER THE ECONOMIC RECOVERY STRENGTHENS.”
This is the phrase that Chicago Fed President Charles Evans must have written because it is a tribute to his concept of targeting a 7/3 growth story: 7% unemployment rate and 3% inflation. It is very similar to the Professor Woodford argument that the FED OUGHT to target NOMINAL GDP. The desire to basically keep accommodation in place regardless of the underlying growth for a considerable time is the FED communicating that it will err on the side of inflation, no surprise and it certainly means that the GOLD market has well understood the theoretical basis of the Bernanke FED far better than all the economists OCCUPYING WALL STREET. The markets are TOTALLY CONFUSED for all it has to guide it is the THEORETICAL BIASES OF A SOCIAL SCIENCE AMASS WITH ASSUMPTIONS. We are back to the old joke, “LET’S ASSUME WE HAVE A CAN OPENER.”
***CNBC’s STEVE LIESMAN asked Bernanke a very pertinent question: “Does this mean that tolerance of inflation has grown, if not what is the point?” Chairman Bernanke answered: “The goal isn’t to intentionally raise inflation. We still believe that inflation will be close to our target.”
The Chairman’s answer reflects that Bernanke returns to his view that “OUTPUT GAPS” matter. The FED can flood the market with liquidity because with unemployment so high there is no pressure on prices, nor will there be. This of course has been the FED‘s mantra and is the basis for moving to the theoretical principal of open-ended ASSET BUYING or targeting NGDP by any other name.
The problem with all this theory is that it undermines the TRANSMISSION MECHANISM of the interest markets. It is one thing when the FED acts to either stimulate the economy or slow the economy by raising or lowering the FED FUNDS RATE, but when the FED runs a massive program of LARGE SCALE ASSET PURCHASES (LSAP) it is telling the market where to set rates.
The death of the BOND VIGILANTE and thus the purveyors of the TRANSMISSION MECHANISM, means that the FED has moved the U.S. economy to an entire new arena. In a HAT TIP to an avid reader of the blog and long time friend KM, the question arises from an intro comparative economic text: It seems that the U.S. financial markets have transitioned from being a market driven force to that of being a COMMAND ECONOMY. Prices for U.S. debt is now priced from the top down rather than bottom up. The market forces no longer establish what the value of U.S. debt.
This is a very dangerous time as we are now dependent on the theoreticians to establish prices. How comfortable are the international markets going to be in realizing that their vaults are full of assets based on the theoretical value set by FED MODELS. The last 10 years have certainly revealed how badly flawed the FED‘s policy has been.
***The Federal Reserve screwed Mario Draghi today with its Woodford-enhanced policy. The U.S. DOLLAR fell as markets assessed that the FED would create growth at any cost. A declining DOLLAR is not what will aid the DEBT stressed European countries. The ECB‘s recent maneuvers by Draghi, “whatever it takes,” cannot overcome the theoretical nature of FED policy. The EURO does not need to rally as that will do nothing to alleviate the 25% unemployment rate in Spain or the high unemployment throughout the rest of the peripheral nations. To confirm the problems of dueling CENTRAL BANKS, the GOLD/EUR cross mad all time highs afte the FOMC statement was released. Bernanke also painted himself and his predecessor into a corner by admitting that monetary policy’s because impact is on ASSET PRICES.
If monetary policy is principally about affecting asset prices then Greenspan’s missives about not being to identify asset bubbles turns the central bank into a serial bubble blower by default. Mr. Bill White has always maintained that the best role for a central bank is to “lean against the wind,” or act in an anti-cyclical manner. In admitting that the greatest impact of money policy the Bernanke points his finger at Greenspan as being its bagman, he left rates far too low for far too long.
***The BOND markets are most certainly broken as a TRANSMISSION MECHANISM but it will be important to monitor the U.S. YIELD CURVE to see if there is any movement out of U.S. debt that could put pressure on the FED‘s approach to fulfilling its dual mandate.
Also, the question arises: Now that the ECB and the FED have both entered upon new stimulus programs, WILL THE JAPANESE ALLOW THEMSELVES TO BE THE SUCKER IN THE GAME AND MAINTAIN ITS OVERVALUED YEN? Let’s keep our eyes on the GOLD/YEN CROSS AND THE NIKKEI FOR POSSIBLE MOVES ON THE YEN BY THE BOJ and Ministry of Finance (MOF). But of course this is only theoretical. As usual the markets will test this theories and we will react accordingly, for unlike the FED, Markets Can Remain Irrational Far Longer Then You and I Can Remain Solvent (John Maynard Keynes).
***Now let me pose a THEORETICAL QUESTION: If the Fed Chairman presents the looming “Fiscal Cliff” as a severe problem and the failure of Congress to deal with the issue forces the FOMC to embark upon a round of open-ended QE, hasn’t the FED in fact encroached upon the realm of FISCAL POLICY? (Of course, just theoretically.)
Tags: asset buying, Bernanke, BOJ, Draghi, ECB, Fed, fiscal cliff, FOMC, MBS, Michael Woodford, NGDP, output gaps, QE, transmission mechanism, U.S. Dollar, U.S. yield curve, Yen
September 13, 2012 at 10:05 pm |
Hi Yra-
Excellent final question, and the answer is indeed ‘yes’ that the Fed is trying to alternatively co-opt or possibly just feels forced to step in to counter the absolutely dysfunctional inability of the Executive and Congress to come up with any effective fiscal policy.
The problem is it can never be effective if in addition to the interest rate transmission mechanism being broken, the monetary policy transmission mechanism is also broken. No amount of additional liquidity can replace effective taxation, regulation and trade policies. It would be nice if we even had a rational set of any of the above.
Great post on how the Fed is playing a part (along with the socialist instincts of the administration) in transforming the US into a command economy. What a great example of winning the (Cold) War, and losing the Peace.
-AR
September 13, 2012 at 10:31 pm |
Yra, another great piece. Big Ben has finally jumped the shark! Michael Woodford’s piece is significant but no less stolen from Eggertsson at the Fed Reserve bank of NY. As he put out last June while studying the Mistake of 1937, monetary policy is non-linear at the zero-bound. If you’re going to lean against anything, it’s the fear of deflation at the zero-bound.
Speaking of inflation, the Bernank better hope his model of the output gap and the Phillips curve is correct. Odds are he hasn’t read “Will the Real Phillips Curve Please Stand Up?” by John Hussman but I think we all should. Who says that general price inflation only happens at lower rates of unemployment? He’s found one heck of a stage for his experiment, but hey, what’s a fully functional advanced economy amongst friends anyways?
September 13, 2012 at 11:35 pm |
It seems that the U.S. financial markets have transitioned from being a market driven force to that of being a COMMAND ECONOMY
Finally you come around to understand why investors leave the equity market in droves! Just wait till the Fed commences OUTRIGHT EQUITY PURCHASES within a year (why did Bernanke not name this tool during the presser, I wonder?)
Unlike his predecessor, with all his mighty tools and outright purchases, Bernanke (and Draghi, for that matter) can not guarantee VIX below 15 all along. The fear will come back. So will the dollar. (in fact, chances are very soon, goven the geopolitical recent events).
September 14, 2012 at 4:09 am |
as a bond trader I can just say that there is one more unemployed as of yesterday. (not that it was easy during the past 4 years…)
September 14, 2012 at 5:08 am |
Dan–did u lose your job or just thinking ahead????
September 14, 2012 at 5:17 am |
thinking ahead. the bond trading has become harder and harder in recent years. yesterday was just another nail in the coffin of bond trading.
as you so precisely said – bond vigilantes are dead. the worst thing is we even can’t be looking forward to their resurrection – because if it ever happens it will be ugly.
btw i really enjoy your blog. good trading!
September 14, 2012 at 5:36 am |
Dan–let me take the other side.As I see what the FED did yesterday my view is that this policy change will create great opportunities for bond traders as everybody in that area is goign to be reacting more vehemently to inflation and unemployment data and the yield curve are going to be where the greatest action is going to take place and for the time forward it is global in nature.The bond markets are going to be the palce of great volatility and volume–and that is not theoretical—the BOND Vigilantes may be comatose but as I say every morning the dead will be resurrected.
September 14, 2012 at 7:25 am |
The fed;s monetary policies yesterday created such a skew like I have never seen before in the 10 yr T bill to the MBS’s derivatives market. At one point catching the spread well above 24/32. All the previous releases of monetary policies hurts the MBS market, however, yesterday nobody is looking at the inflationary aspect of decision. Today is no different as the 10 year widens away from the derivative market….Is anything positive going to come from this? The iceberg has not even been spotted for what inflation can really do at this point from policis, oil at $4 plus and commodities that have not hit the American pockets….Inflation stagflation who cares at this point it seems like?
September 14, 2012 at 7:26 am |
“WHEN DID MONETARY POLICY BECOME THE LABORATORY OF ACADEMIC THEORISTS?” Excellent question! It fits right in there with “When did industry czars become necessary in capitalism?” The mutation of the U.S. economy is running its course; we are becoming the world’s largest third-world nation where “command and control” is the tool of monarchs and dictators. Equity markets are stalls for “investors” to be milked by algos on every trade, courtesy of co-location and purchased order flow. “Exchanges” are now publicly owned institutions making more money selling inside information than in clearing trades. Bond markets are the central planning committee’s mechanism for rationing opportunity, and fiscal policy has become the social means to redistribute wealth. Is it any wonder we “worship” the false god of academic brilliance?
Historically, academicians have served the useful purpose of finding evidence to support or refute hypothesis that attempt to explain observations in nature. Occasionally, these lead to lovely, powerful and productive discovery:
Boyle’s Law, Ohm’s Law, and may others in the physical sciences. Academic hubris tries to transplant this practice into the social sciences and usually fails miserably with its theories. The term “physics envy” explains our ignorance in acting as if there were Laws of Science governing our study of economics and formulation of policy. Ben and his comrades are brilliant scholars. They may want to pay homage to another among them by taking their advice, but they should confine their work to the academic journals. These venues, unlike the rough world of human interaction, are much better places to begin with “Imagine a perfect world: Now let’s design an explanation and write an equation to fit it”
September 14, 2012 at 7:35 am |
Professor Waspi—I am offering a full tenured position at the University of hard knox
September 14, 2012 at 8:39 am |
Yra,
Accepted with gratitute and humility!
Kevin
September 14, 2012 at 9:09 am |
While the lack of inflation means that Bernanke cannot be characterized as a G. William Miller doppleganger, doesn’t his overt acquiesence to what Sen. Schumer demanded at the last round of testimony make this passingly like the late phase of the Arthur Burns regime? The previously effective Fed Chairman caved in to requests for a monetary expansion in the belief it would help him get re-appointed, and the weak economy meant he could get away with it and all the trouble came later (i.e. under Miller.)
And absolutely agree with your opinion on the future of bond trading: we are likely headed back to a much more volatile phase, and all the guys who came up during the ‘golden age’ that seems to be lapsing are going to need to learn how to be ‘happy bears’… I am personally looking forward to getting back to a late 1970’s style bond market. It was so easing and massively profitable to be a bear back then…
…ahhhh the Good Old Days!! …when trading bonds was an easy transition from trading Bellies. After all, they’re both half a pound of fat.
-AR
September 14, 2012 at 11:24 am |
FYI Yra: someone has been re-posting your blog posts in their entirety on Wall Street Oasis.
http://www.wallstreetoasis.com/blog/for-chairman-bernanke-when-did-monetary-policy-become-the-laboratory-of-academic-theorists
Thanks again for your thoughts.
-GB
September 14, 2012 at 12:26 pm |
Greg–thanks for the acknowledgment and they asked me ahead of time and was glad to have another outlet .Hope many are reading and learning
September 14, 2012 at 10:21 pm |
Hello Yra,
Really like your blog and it’s attention to deep-thinking analysis.
Btw Bernanke implies that there is no need to worry about a surge in inflation with all this QE because the labour market is so weak there will be no demands for increased wages. But I can’t believe that he’s so ignorant of the possibility that all the QE will devalue the US dollar and thus increase inflation through much higher costs for imported goods.
See ya mate
September 16, 2012 at 6:29 am |
Yra,
Did you happen to listen to Ray Dalio’s interview last week with the CFR – http://www.cfr.org/united-states/ceo-speaker-series-conversation-ray-dalio/p29012. He basically talked about his template about how the economy works and what phase both the US and Europe situation is in. First of all, I find Ray’s “template” to be pretty accurate in putting the pieces together as to what is happening on a macro level in any deleveraging cycle, but getting more micro to see where we are in that gets kind of foggy….the reason I bring it up is that Ray (from listening to the interview) seems to stress that (in the Euro zone) Southern Europe has the votes to keep northern Europe to just “print money, monetize the debt, and essentially transfer the wealth from north to south. He then says that he believes there is a more likely outcome that Germany will be leaving the Euro zone (not southern Europe). I remember 4-5 years ago when you spoke in Vegas for a CME thing and you talked about this whole euro zone crisis and you said you’ve talked with the CME to not de-list the D-Mark…Do you think a scenario like this can occur? Also, staying on topic of Dalio’s macro views, he basically sounds supportive of the FEDs action to keep pumping more money into the economy (QE) – but he says we are in the stage of the cycle that “private sector” credit growth (in relation to income growth) is will drive the economy. To me, this seems pretty evident with the steeping of the yield curve and FED action – the FED sees Inflation in terms of Income Growth and Asset prices which has a great influence on private sector credit growth…I can only get credit in relation to the assets I own (house) or my income level – if both of these things are in deflation my credit growth will also be. The amount of credit I can receive and spend on GDP really makes no differences on what the prices of commodities are (the higher a commodity price goes, the more farmers will come to the table willing to sell/hedge that price in, with no buy order under the market…thus pushing prices back down…when I was in the corn pits, my boss would say, “with commodities, the only way to get prices down is to push them up and find some sellers”)…it seems like this is what Ben has been thinking…Inflation expectation are simply income growth and financial assets which in turn produce credit for the average man to spend and add to GDP.
September 16, 2012 at 12:17 pm |
Jason–first of all a very thoughtful post.I didn’t hear the Dalio interview but I have been a long time admirer of the Bridgewater thought process–another example of the power of non-MBA thought process and the whole of political-economic analysis being the backbone of the global-macro world.Yes,I think Germany can leave but it is a very complex world and the costs would have to evaluated.i think Draghi is pushing so hard so fast because he won’t the costs of Germany leaving to rise dramatically.I have written over the last three years that the German exodus is a possibility and if that occurs European politics will become even more interesting as Germany would turn east towards Russia–remember almost 50% of Germany’s energy comes from Russia and former Chancellor Gerhard Schroeder is a major player in Gazprom–we do not hear much from Herr Schroeder so stay tuned.Many think that Germany has no choice but to play the role of Europe’s deep pocket,but I am not so sure the game can go on forever.On the defaltion question which I am apt to accept as Richard Koo’s Balance Sheet Recession–the FED wants to reflate its way out of the debt overhang and post the inflating away the debts –the FED is more comfortable in fighting inflation.At what cost as a society we don’t know but as Friday’s blog stated–its just a laboratory for theroticians to play in –if they are wrong in their assumptions—oh well back to building new models.