In Chair Yellen’s speech on Thursday–“Inflation Dynamics and Monetary Policy”–she walked backed comments from last week’s UBER-dovish press conference. My first impression, given the wonkish nature of the speech, was that she plagiarized Stanley Fischer’s speech at Jackson Hole, or merely bought it at an online economic website. Second, the Yellen speech did hint at a possible answer to the aggressiveness of Jim Bullard’s desire for the Fed to raise rates as soon as possible. After rereading the speech, it seems that Yellen was NOW willing to raise rates and be part of the FOMC members pushing for a rate rise before the end of 2015. Why?
It seems that the battle at the FOMC meeting was about financial instability. Since the market was only estimating a 35% probability of a rate increase in September, Yellen didn’t want to upset the financial markets. The economic data said yes but the markets were leaning toward NO–coupled with the musings of Larry Summers, Ray Dalio and Jeff Gundlach. St. Louis Fed President Bullard and others must have argued that NOT RAISING RATES WOULD BE MORE DESTABILIZING BECAUSE OF WHAT RAISED FEARS AT THE FED AS THE UNCERTAINTY BRED INSTABILITY. The continued slide in the global equity markets must have convinced Yellen that Bullard et. al were correct about the markets’ response in that there’s nothing destabilizing about raising rates in the future. Looks like Janet Yellen has received an education in market reaction function.
There is no economic model for the predictability of markets and to set policy based on anticipated short-term responses is futile. If you are going to be data dependent, then be data dependent. That is the lesson from the quick about-face by Janet Yellen.
One paragraph in her speech suggested that the discussion by Santelli-Harris on September 21 had great relevance to possible Fed fears:
“An unexpected decline in inflation that is sizable and persistent can also be costly because it increases the debt burdens of borrowers. Consider homeowners who take out a conventional fixed-rate mortgage, with the expectation that inflation will remain close to 2 percent and their nominal incomes will rise about 4 percent per year. If the economy were instead to experience chronic mild deflation accompanied by flat or declining nominal incomes, then after a few years the homeowners might find it noticeably more difficult to cover their monthly mortgage payments than they had originally anticipated.”
This is the debt overhang scenario that extrapolated onto a global economy with a massive debt overhang suffers the stress of not being able to SERVICE the huge amount of debt when the DOLLAR RISES AND PRICES FALL. This is simple global macro but it certainly weighs on the FED when Chair Yellen increases the discussion about international developments. Yellen may have offered some capitulation to the Bullard group but the global situation will continue to be the headwind of choice for the Chair’s wing of the FOMC.
***The following story from Friday’s Financial Times was lost in the HARMONIC CONVERGENCE (a la Ghostbusters–h/t Kevin M.)–The Pope’s visit, Yellen, Putin, Xi, Boehner and VW–“Macron Calls For Eurozone to Have Its Own Treasury and Parliament.” Emmanuel Macron is the French economic minister (and considered a mainstream thinker and capitalist in a socialist government cabinet). The article begins with a summation by the reporters, Giugliano and Gordon: “The French economy minister has called on eurozone member states to set up permanent transfer mechanisms to channel funds from richer states to countries in difficulty, saying that the currency union cannot survive in its current form.”
THIS IS THE CRUX OF THE EUROPEAN DILEMMA! AND A FRENCH MINISTER OPENLY CALLING FOR THE DEVOLUTION OF SOVEREIGN POWER TO A CENTRAL AUTHORITY OUGHT TO HAVE BEEN FRONT PAGE HEADLINES! The French have been the most opposed to a true federal system and have pushed for a federation of sovereign nations, making this proposal all the more FANTASTIC. This is the existential question for the entire European project for if the wealthy do not transfer income to the poorer nations the entire project’s existence is threatened. The Germans have been opposed to a transfer authority as long as there is no central authority for fiscal and budget harmonization. The article continues:
“Mr. Macron called for countries to set up a structure of permanent fiscal transfers to reduce the divergence caused by policies such as the ECB‘s single interest rate. He argued that a system of transfers was necessary to support countries in trouble to reform and to combat the rise of populism across Europe.”
My quick answer in the tradition of Jean-Claude Trichet: ABSURD. A proposal like this without national referenda in every EU country would unleash populism throughout Europe. It was in the pages of the FT that German economist Otmar Issing said any such transfer system would be taxation without representation. The French, along with others, are feeling some Schadenfreude over the VW debacle and believe that Germany is now wounded and therefore willing to compromise on some previous hardened positions on fiscal austerity.
This is a serious issue and we should expect to hear more about the echoes from Macron’s proposal. It may be important to remind the French and others that Bundesbank President Jens Weidmann has recently been voicing greater opposition to more unconditional QE by the ECB. (An important note to the world: As of November 1, JENS WEIDMANN will also assume the chairmanship of the BIS.) French Schadenfreude will be very short-lived as will Mario Draghi’s. The Germans will have a great amount of influence on global financial concerns.
***In a new addition to the HARMONIC CONVERGENCE it is being reported that the Catalonia separatists have won the vote in today’s election. Though the issue is non-binding it will send a message that all is not well in Spain and may have an impact on the European peripheral bond markets, as well as a negative impact on the euro. It’s too early to tell but be aware.