Mr. Santelli interviewed me today and the topic evolved into Christine Lagarde and the IMF. The conversation was based on previous blogs as we discussed IMF culpability in the Greek debt crisis. The Santelli Exchange is linked below (click on the image). Also, I would advise reading the comments on the previous blog, especially the words of wisdom from University of Illinois finance professor Kevin Waspi.
***Tomorrow the ECB meets. The public pronouncement of its interest rate decision hits the wires at 6:45 a.m., followed by a 7:30 a.m. press conference (all times CST). It is highly doubtful that the ECB will change any of its current policies but we will have to listen for any hint as to how they may frontload its QE purchases as suggested by ECB Executive Board Member Couere. The French member of the ECB board advised that the central bank would purchase some excess bonds in June because of the slowdown of activity in July and August. This is a bad idea and shows how little Mr. Couere understands markets. The ECB should hold off buying in June when market liquidity is greater and utilize more firepower for the thinned out summer markets when ECB intervention can have greater impact and allow the bank to push sovereign bond yields to desired levels with much less resistance.
It could be a wonderful world if central bankers would bother to respect and understand markets rather than fear them. Today the EURO had a very sustained rally as it moved more than two percent higher versus the dollar and a significant amount against the YEN as the EUR/YEN closed above its 200-day moving average for the first time since January 2015. Did the euro rally because of possible good news from Greece or was it the above consensus rise in the CPI data out of Europe? It seems that the market wants to believe that an early end to a deflationary threat is positive for the EURO.
***Last night the Reserve Bank of Australia decided to keep its overnight interest rate at 2.0% and the policy statement was very tepid and non-committal to any type of forward guidance. What did catch my eye was this paragraph:
“The Federal Reserve is expected to start increasing its policy rate later this year, but some other major central banks are continuing to ease policy. Hence, global financial conditions remain very accommodative. Despite some increases in bond yields recently, long-term borrowing rates for sovereigns and creditworthy private borrowers remain remarkably low.”
Did Governor Stevens tip the hand of conversations with Stanley Fischer and inform global investors that there is nothing to fear of 1% rates? A FED rise will have minimal impact on global financial liquidity. Just something to keep in mind that another central bank is noting possible Federal Reserve action.
Tags: ECB, Euro, Euro/Yen, Fed, IMF, Mario Draghi, RBA, Stanley Fischer
June 3, 2015 at 8:25 am |
Great points. Bond markets are eating this up at this time. Headed back to Nov 2014 levels with the 10 yr. The stagnant range will be showing its face by the end of the 2nd quarter, lets watch and see as the spark is right there.
June 3, 2015 at 12:19 pm |
Yra (or anyone in group) Would you give me a comment on this? I realize this is not the way the FED is headed.
Alternative for Monetary Policy
It has widely been reported that the FED plans to vey gradually begin raising the Fed Funds rate, starting at some point in 2015. I would like to propose an alternative.
Monetary policy (QE, ZIRP) has created a number of significant problems, which in my opinion, will not be adequately addressed by a series of small incremental raises in the Fed Funds rate:
1) Lack of Confidence in the Economy and Markets. Many consumers, investors and business people believe that the recovery in the markets and economy have been rigged, via ultra-low interest rates and financial engineering, and is therefore not sustainable. This is holding back consumer and business spending and investment.
2) Taper Tantrums. Even the hint of an increase in the chance of a FED tightening causes an extreme market reaction, due to the lack of confidence in the sustainability of the recovery. As soon as the first tightening occurs, speculation about timing of the next one will begin. The markets and economy may suffer, as a result.
3) Mis-pricing of assets. The financial crisis was caused in large part (though far from exclusively) by the mis-pricing of less that 2 $Trillion of sub-prime CDOs. Current monetary policy of Central Banks has led to the mis-pricing of at least several Tens of $Trillions of assets, worldwide.
4) The Federal Reserve will have few tools to fight a new recession, should it begin soon. I would guess that negative interest rates and new rounds of QE would panic investors, consumers, and business people.
5) Current Monetary Policy is deflationary. Interest rates are a zero sum game. Every penny saved by borrowers is lost income to lenders. Most people and companies are lenders, (have a savings account, money market account, certificate of deposit, pension plan that holds such assets). Far fewer are borrowers. At this point in the cycle, I believe that income lost by lenders is more significant to the economy, than the money saved by borrowers. The income lost by lenders is lost immediately and forever, but the debt accumulated by borrowers lasts for years.
6) Debt is being accumulated at levels far higher than it would be if interest rates were at realistic levels. I believe this excessive subsidized debt accumulation is a weight on the economy (weakens balance sheets) and steals from future demand, weakening the economy, in both the short and long term. Credit quality is deteriorating in some sectors. For example, subprime auto loan volumes are surging, and the term of these loans is increasing.
7) Recent Monetary Policy sends a message that the Federal Reserve has little confidence in the economy.
8) Decreasing market liquidity. Uncertainty as to what will happen when rates normalize is contributing to dealer hesitancy to hold large inventories.
A series of anticipated incremental rises in the Fed Funds rate is also problematic in that:
1) It is impossible to correctly time the tightening. We are always looking at economic data in the rear view mirror. What happened in the last few months is not very predictive of what the economy will do 6 months from now, especially post Financial Crisis. Most economists missed even the obvious harbingers of the Financial Crisis in 2006/2007, and it is harder to predict the future course of the economy in the current environment.
2) May accelerate strengthening of the dollar, which will hurt our exporters and multi-national corporations. Incremental tightenings will be looming in the future for the next several years, strengthening the dollar.
Governor Stanley Fischer recently said, “What we are thinking about is raising the interest rate from zero, which is an ultra-expansionary monetary policy to a quarter percent, which is an extremely expansionary monetary policy. This will be a gradual process.”
In my opinion, such policy will do little to alleviate the problems listed above. The economy will still be viewed as rigged and kept afloat by an extremely expansionary policy.
As you know, trading in the Fed Funds market has declined drastically since the onset of the financial crisis (as economist Lawrence Berra would say, “Interest Rates have gotten so low, no one borrows there anymore”).
The Fed Funds market needs to be made functional again, by draining Excess Reserves held at the Federal Reserve, or converting these Excess Reserves to Required Reserves, so that banks need to borrow in the Fed Funds rate, on a regular basis, in order to meet reserve requirements.
So what is the best course of monetary policy for the near future? I believe that the alternative that has the best chance for success is to float the Fed Funds rate.
Floating Fed Funds will have the following benefits—–
1) Give investors, the business community, and the country as a whole, confidence that the USA economy is not “rigged” and asset prices are sustainable.
2) Discover the right price of credit/interest rates, based on real-time supply and demand, not by an estimate as to what might happen in the future.
3) Allow asset prices to find a reasonable “free market” value, not subsidized by ultra-low financing rates. This would help to shortstop future bubbles.
4) Incentivize companies to make capital investments, without fear that the current economy is being kept afloat only by interest rate subsidies.
5) Give conservative savers a fair market-based rate of return.
6) Help us to minimize future “boom/bust” cycles, by allowing the free market to appropriately determine the level of short term interest rates and ration credit.
7) Eliminate “taper tantrums”.
8) May help to stabilize the dollar, by eliminating the anticipation of a series of incremental tightenings.
If you really think about it, floating the Fed Funds rate effectively addresses in full, or in part, all the issues discussed in this memorandum.
I remember that in the 1980s, the Federal Reserve moved away from targeting the Fed Funds rate to targeting Money Supply, and fairly quickly reversed back to targeting Fed Funds. However, the situation is quite different today. The major concern then was to keep inflation under control, long term. My view is that the major concern now is to restore market and economic credibility.
I believe that such a bold move to a “free market” based Fed Funds rate would be welcomed by the markets, and would be viewed as a vote of confidence by the Federal Reserve in the economy.
June 4, 2015 at 12:21 pm |
So assuming it’s true Putin is buying dollars, PM bugs call that a gold purchase?
June 6, 2015 at 2:35 am |
From The Economist. Investors are caught between weak growth and central-bank policy. A poll by Bank of America found that a net 47% of fund managers were overweight equities, that is, they had a higher allocation than normal to the stock market. Investors have to take risks if they are going to make decent returns.
June 8, 2015 at 2:30 pm |
shocked —i am not ignoring you but that will be an entire blog
June 8, 2015 at 4:29 pm |
Yra- I knew you would reply at some point.
The thing that no one even talks about is that interest raters are a zero sum game…..every cent saved by borrowers is lost income to conservative savers/lenders.
At this point in the business cycle, most of the borrowers (individuals and corporations) have refinanced, but conservative savers are making nothing.
The net result is a decrease in income and spending, which is a huge drag on the economy.
It is tough to even get anyone to consider this point of view.
It is dogma that low interest rates strengthen the economy, but at this point in the business cycle, low rates are weakening the economy, IMO.