I’m posting this week’s podcast with the highly respected Peter Boockvar. This is one of the best interviews we’ve done with Richard Bonugli as we get into foreign currency, yield curves, energy policy surrounding nuclear power plants, and as usual, an in-depth discussion on precious metals.
The podcast was recorded Tuesday, prior to the interest rate decisions from the Bank of Canada, the Bank of Japan and the European Central Bank.
Last week the world’s bond markets experienced an assault propagated by the MISERABLE U.S. five-year Treasury note auction on Wednesday followed by a more dismal seven-year sale on Thursday. Also, the Australian and KIWI 10-year notes suffered massive bouts of volatility even as the RBA and RBNZ intervened with more QE to stem the rise on the long end. We at Notes From Underground have warned that the markets were attacking the FORWARD GUIDANCE motivations of the world’s monetary authorities by attacking the long end of the yield curve as the area of least resistance because central bank asset purchases around the world have been targeted at debt instruments of much shorter duration.
Forward guidance is a key tool in the Federal Reserve’s arsenal, promoted in a speech long ago by Columbia University professor Michael Woodford at the Jackson Hole Symposium. In a previous communication, the central bank said, “Forward guidance is a tool that central banks use to provide communication to the public about the likely course of monetary policy.”
This tool allows the FED to establish a time-directed path for interest rates so that the MARKET does not suffer shocks from an upward surprise move in rates.
There is no question that the world’s central banks are all living under the shadow of doubt as investors and financial markets are questioning the efficacy of the zero lower bound. The sense of always doing more in an effort to attain a self-conjured 2% level of inflation has led to the continued downward slide in interest rates.
On this note, last week we saw the Powell Fed lower the target range for the fed funds rate by 25 basis points — and its interest on excess reserves rate by 30 basis points — as congestion in the financial plumbing sent overnight rates soaring. (For those who are interested in the nuances, I am linking to one of many splendid pieces from Bloomberg reporters Liz McCormick and Alexandra Harris detailing out the repo market mess.)
Never has so much money been riding on ONE WORD from a monetary authority. The issue isn’t the idea of FED PATIENCE in regards to raising rates for if the FED increases the effective rate to 37 basis points from 12 basis points IT IS MEANINGLESS. The issue for the FED is the huge pile of bank reserves sitting at the central bank to the tune of $2.7 TRILLION (and let’s not forget the FED‘s $4.5 TRILLION balance sheet). If the economy begins to heat up and banks begin to circulate those RESERVES, the FED will have a velocity of money problem as the ECONOMY MAY BE AT SOME LEVEL OF FULL EMPLOYMENT. It’s not an interest rate problem for the FED but a RESERVE PROBLEM.
The reference of 19 ways to leave your lover is a reference to Janet Yellen’s Labor Market Condition Index (LMCI), which is what the Fed chair noted as the most important “dashboard” for measuring SLACK in the labor market. To achieve a true measure of labor market slack it is important for the Fed to dig deep into the statistical data of the unemployment report giving the Fed latitude in its decision-making. Remember, the Fed has twice moved the parameters of the jobs data as the different thresholds established by the Fed were breached quicker than anticipated. First it was an unemployment rate of 7 percent and then moved again to 6.5 percent. The threshold was then moved lower again as slack and its impact on WAGE PRICES was deemed to be the best measure of the health of the jobs market. If the Fed’s focus is wages then the FOMC statement tomorrow should be unchanged as the recent data has continued to reflect that wage gains are stagnant.
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.
A quick note before we enter the Fed’s two-day meeting. I am reposting a note from a few weeks ago when I conjectured that Chairman Yellen was not the keeper of the Greenspan Put. In the present realm of depressed wages, Yellen would err on the side of allowing corporate profits to soften if it meant an increase of wages for the middle level wage earner. Corporate profits as a percentage of GDP are at elevated levels because capital has been well rewarded from the effects of globalization while the massive increase in the global wage pool has kept downward pressure on wage rates in the developed world economies. Throw in the historical low borrowing rates set by the world’s central banks and the result is enhanced corporate profits. The FED has been enamored with the idea of “forward guidance” and went so far as to put in a quantitative threshold as a measure of its commitment. The Bank of England has already dispensed with its numeric-based forward guidance and seems to have accepted a more nuanced and qualitative response to its mandate.
I am going to take a well-deserved hiatus but I wanted to list some “quick hitters” on the issues facing the markets in the coming weeks. The Yellen testimony has been digested and regurgitated (ad nauseam) and the bottom line is Chairwoman Yellen is singing from the same hymnal as her predecessor. The stock market investors/traders are comfortable with a known known and as readers of NOTES are well aware markets appreciate as much certainty as possible. BUT I WARN EQUITY BULLS WHO BLINDLY FOLLOW THE FED LIQUIDITY MODEL: Janet Yellen is a labor economist of Keynesian predilections.