The FED meeting begins tomorrow and concludes Wednesday with a full-blown Janet Yellen press conference. The FOMC is expected to continue the path of TAPERING by removing another $10 BILLION of asset purchases but still continuing to add to its massive balance sheet. There is talk among the “pundits” about Chair Yellen raising the expectations of a FED move to increase interest rates sooner than the market predicts. Concern has grown because several FOMC members have raised the issue of higher REVERSE REPO and IOER (INTEREST ON EXCESS RESERVES) RATES in an effort to drain some of the vast amounts of liquidity sloshing around in the banking system.
BOE Governor Mark Carney’s Mansion House speech caused some investors to think that Yellen would follow on the heels of Carney’s statement. “There’s already great speculation about the exact timing of the first rate hike and this decision is becoming more balanced. IT COULD HAPPEN SOONER THAN MARKETS CURRENTLY EXPECT.” Mark Carney’s mere mention of a quicker rise in the British interest rates caused the POUND to rally, U.K. short-term rates to rise and even the nearby EURODOLLAR FUTURES CONTRACTS to drop as U.S. yields rose. (Below is the U.K. 2/10 yield curve to illustrate how dynamic the Friday’s move was in response to Carney. Interestingly, GOLD held its gains even in the face of market fears about an increase in the overnight interest rates and I don’t give credence to the problems in Iraq because political conflagrations are not bullish gold for more than the initial outbreak which leads knee-jerk buyers to be quick sellers.)
U.S. short rates have firmed because, as I wrote last week, Hilsenrath sounded the alarm about a faster move by the FED in an effort to undo some of the risk that has followed the FED‘s QE programs and its reliance on forward guidance. The use of FORWARD GUIDANCE as a policy tool of the world’s large central banks may be responsible for much of the risk imbalances that Governor Jeremy Stein has warned about. Mark Carney has been a previous adherent to the FORWARD GUIDANCE tool in a zero-bound interest rate environment, but I BELIEVE CARNEY HAS NOW DISTANCED HIMSELF FROM THE WANTON USE OF FORWARD GUIDANCE. Governor Carney’s speech created something that FORWARD GUIDANCE has strove to contain in monetary policy: AMBIGUITY. The FED may want to follow the British by inserting some UNCERTAINTY into the market, thus giving investors some sense of unease. Greater uncertainty will hopefully lead to more realistic pricing of risk.
In addition, it seems that Yellen would do well to remove the FORWARD GUIDANCE mantra from the FOMC as the new Fed Vice Chair Stanley Fischer has been on record many times advising against the use of forward guidance. In a WSJ article September 23, “The Key to Forward Guidance? Don’t Give It,” Fischer is quotes as saying: “You can’t expect the Fed to spell out what it’s going to do. Why? Because it doesn’t know. We don’t know what we’ll be doing a year from now. It’s a mistake to try and get too precise.” It is refreshing for the dean of modern central banking theory to admit that central banks just don’t know. Also, Fischer notes that too much forward guidance inhibits monetary policy flexibility. It is time for others to follow the lead of Governor Carney and have AMBIGUITY force a repricing of risk.
***In tomorrow’s Financial Times there is a market insight piece by Mohamed El-Erian, “Time to Take Some Chips Off the Table.” El-Erian is one of the better thinkers in the global macro world and his opinions carry more weight than many others in the land of punditry. The market’s complacency in response to the Fed’s liquidity creation has been “excessive and irresponsible risk-taking.” El-Erian is warning that the Fed’s policy is leading to some very highly exposed investment strategies. In a bow to Governor Carney (not in name but in spirit), El-Erian sums up his stance: “In their efforts to promote growth and jobs, central banks are trading the possibility of immediate economic gains for a growing risk of financial stability later.” The warning sirens are growing louder.
Tags: BOE, eurodollar futures, Fed, FOMC, forward guidance, IOER, Janet Yellen, Mark Carney, QE, reverse repo, Stanley Fischer, tapering, U.K. 2/10 curve
June 16, 2014 at 7:20 pm |
Yra- Good points made. Forward Guidance has always been ridiculous. The FED has no idea what conditions will be a year from now.
In 2007-2008, they didn’t realize the economy was crumbling, even as it was happening (let alone in advance).
June 17, 2014 at 8:38 am |
RISK ON
June 17, 2014 at 10:16 am |
Yra- You said
“Interestingly, GOLD held its gains even in the face of market fears about an increase in the overnight interest rates”
To throw out a theory (that I am not at all sure about)……….People believe that QE/ZIRP lead to the equity/bond boom, so you wouldn’t want to own Gold if these other assets are moving up. So if the FED were to tighten, equities/bonds may be a poor investments, so you would buy the alternatives (Gold/Silver).
Why? The economies in the USA and China have so much debt that a tightening could cause a debt contraction, with consequences that are difficult to predict.
As I have said before, I think the FED may float some trial balloons on tightening, but will actually keep monetary policy very loose (relative to the strength of the economy).
June 17, 2014 at 4:55 pm |
Shocked–interesting thought and I would agree with you but i will wait to see how the yield curves perform in your theoretical world–you know i believe that gold is a hedge against the market’s fear of the fed’s deflation phobia—as bernanke was the ultimate ’37er gold responded to the threat of monetization of debt–those pundits who claim gold has sold off because of low inflation in spite of fed policies are drinking from a fountain of bad thought
June 17, 2014 at 10:07 pm |
Attempting to think out of the box concerning gold, is there any correlation with availability of consumer credit?
June 18, 2014 at 6:20 am |
chicken–never proceeded on that path because the ramifications would appear in real time and too much college debt and other non demand areas where consumer credit shows and as I have argued on Santelli for 5 years –college debt is a drag on the economy
June 18, 2014 at 8:52 am |
Yra and Chicken. interesting point on college debt. It seems to me that the demand for the typical kid coming out of college is pretty low and job prospects not good. This looks like the new normal,to me.
They often end up working in a low paying job and live at home, and many really cannot both pay off their loans and buy beer.