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Fed’s Lacker Says Current Fed Policy Raised Likelihood of Mistakes

Richmond Federal Reserve Bank President Jeffrey Lacker said Thursday that the combination of the continued use of unconventional measures, a very large balance sheet and forward guidance have increased chances for mistakes when the time comes to begin withdrawing monetary stimulus.

 

Highlights from his speech at the Swedbank Economic Outlook Seminar in Stockholm:

 

The Federal Reserve has pursued a number of unconventional policies since the financial crisis of 2007–2008.
 
It lowered the short-term interest rate to near zero in 2008, where it remains today. In addition, it has attempted to influence longer-term interest rates through two channels: “forward guidance” announcements stating that monetary policy will remain accommodative until labor market conditions improve and large-scale long-term asset purchases, including mortgage-backed securities, or MBS.
 
The Fed will face risks as it pursues its “exit strategy” from recent unconventional policies. The combination of a very large balance sheet and forward guidance raises the potential of a timing error when it becomes appropriate to raise rates, as well as the consequences of such an error. In addition, by purchasing MBS, the Fed has targeted a specific private sector asset and engaged in credit policy. Such actions could invite pleading from other sectors and entangle the Fed in distributional politics and threaten its independence.

 

Note that all Fed members’ speeches ncerning QE and economic activity since the last FOMC meeting (September 17-18) are available here.

Eight Reasons Why the Fed Will Not “Taper” in September (An Update)

Just before the FOMC statement on September 18, I think it’s interesting to make an update of my post concerning arguments against “tapering”.

 

Indeed, notwithstanding the fact that the expansionary Fed policy poses risks to financial markets’ stability, especially with the increasing volume of speculative positions (corporate high yield, jumbo loans…), at least eight reasons are still legitimizing a wait-and-see policy in the short term:

 

1/ The lack of short-term agreement on fiscal issues, more specifically on the “continuing resolution” and the 2014 budget. Currently, Republicans insist on keeping automatic budget cuts which will take effect during the 2014 fiscal year (starts on October 1st) and will reach $109B (0.6% of real GDP).

 

-> Senate Majority Leader Harry Reid said last Thursday that deep divisions within the House Republican caucus are imperiling passage of a fiscal year 2014 stop-gap spending bill and threaten both a government shutdown and a default. Note that this bill would keep the government funded until Dec 15 and should include sequestration of $109 billion.

 

2/ The threat of automatic budget cuts, which outcome would not be known from the end of September, comes at a time when growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).

 

-> The last statistics (August retail sales, Wholesale inventories…) suggest that actual growth (3Q) is below 2%.

 

3/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

 

-> Mortgage applications decreased 13.5 percent from one week earlier, according to data from the Mortgage Bankers Association’s (MBA) Weekly Mortgage Applications Survey for the week ending September 6, 2013 (14 declines recorded in the last 17 weeks). The Refinance Index decreased 20 percent from the previous week and has fallen 71 percent from its recent peak (the week of May 3).

 

4/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

 

5/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K

- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.

 

6/ The Syrian conflict could create uncertainty to the extent that the debt ceiling has not been raised. The fact is that military action could increase public spending above expectations and therefore could reduce the time remaining to politicians to find a compromise. Currently, according to Treasury Secretary, the deadline sould be reached by mid-October.

 

-> A diplomatic breakthrough Saturday on securing and destroying Syria’s chemical weapons stockpile averted the threat of U.S. military action for the moment. It means that Syrian conflict is not a longer an argument against tapering.

 

7/ During the G20, IMF noted that currently emerging economies are seen as particularly vulnerable to a tightening of US monetary policy and recommended that policy makers be ready to handle a rise in financial instability. In this context, Fed could choose to give more time to other policy markers.

 

8/ Fed communaction: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.

- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last Beige Book comfirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.

- Finally, some people forget that voters are more “dovish” that non-voters and that they give less press interviews.

- All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.

 

To replace my argurment on Syrian conflict, I choose to focus on future changes at the head of the Fed.

 

8bis/ Changes at the head of the Fed in 2014. The next year, the voting members will be more “hawkish” with the arrival of Fisher (Dallas Fed President) and Plosser (Philadelphia Fed President). Therefore, knowing that committee in place in 2014 would quickly end the asset purchases program, the actual committee could delay “tapering” to compensate.

Eight Reasons Why the Fed Will Not “Taper” in September

Wide divergences among economists are felt in polls showing conflicting results concerning the evolution of Feds’ asset purchase program at the next FOMC meeting (Sept. 17-18). The latest poll (Sept. 6) published by Bloomberg suggests that a majority of economists are expecting a slowdown in the Fed buyback program in September:

 

The Fed will start to cut the monthly asset purchases at the Sept. 17-18 meeting, paring them by $10 billion, according to the median of 34 responses in a Bloomberg survey on Sept. 6, after the jobs data. That’s unchanged from an Aug. 9-13 poll.

 
However, the NABE (National Association of Business Economists) survey shows contradictory results to the extent that only 10% of economists expect “tapering” at the coming FOMC meeting:

 

The economists appear to be more cautious in their outlook than Wall Street banks and even some Fed officials that have looked to the central bank’s September 17-18 meeting as a point to begin easing the pace of bond purchases, currently at $85 billion a month.
 
Only 10% of 220 economists polled expect the wind down to start before the end of September. The survey found 39% expect the first tapering of purchases in the final three months of 2013 with the remainder saying the Fed will hold off at least until 2014.

 

Concerning the next FOMC meeting, my conviction remains the same since May 25, I do not expect any announcement about a slowdown in the Fed purchase program. Notwithstanding the fact that the expansionary Fed policy poses risks to financial markets’ stability, especially with the increasing volume of speculative positions (corporate high yield, jumbo loans…), at least eight reasons are legitimizing a wait-and-see policy in the short term:

 

1/ The lack of short-term agreement on fiscal issues, more specifically on the “continuing resolution” and the 2014 budget. Currently, Republicans insist on keeping automatic budget cuts which will take effect during the 2014 fiscal year (starts on October 1st) and will reach $109B (0.6% of real GDP).

 

2/ The threat of automatic budget cuts, which outcome would not be known from the end of September, comes at a time when growth has been low since the beginning of the year. Indeed, even with an upward revision of the 2Q GDP to 2.5% (QoQ annualized), GDP should increase by 3.1% in 3Q and 4Q to meet the projected 2013 growth defined by the Fed in June (ie 2.45% from 2012 4Q to 2013 4Q).
 

 

- Now, if we look at the latest statistics (retail sales, industrial production, durable goods orders…), the trend remains weak and thus far behind the Fed’s target which is partly linked to a slowdown of the buyback program. As a witness, here‘s what Bernanke said at the June press conference:

 

“If the incoming data are broadly consistent with this forecast, the Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year”

 

3/ The signals from the residential housing market are deteriorating. The recent rise in mortgage rates (highest since April 2011) weighed very negatively on refinancing activity (13 declines recorded in the last 16 weeks) but also on new home sales (-13.4% MoM in July). There is no doubt that existing home sales should fall in August, according to the pending home sales’ decline in July (-1.3% MoM).

 

4/ Inflation is broadly in line (PCE inflation) or below (PCE Core Inflation) the Fed’s forecasts made in June. Anyway it remains well below the 2% target, which is the medium-term reference.

 

5/ Regarding the labor market, it must be recognized that since the set-up of the buyback program (September 2012), pace of nonfarm payrolls has improved whereas unemployment rate has decreased. However, the last report (August) underlines that the short term momentum of NFPs is weakening and is still below the threshold of 200K which is not a minimum acceptable for Fed:
-> Moving average 3 months: 148K
-> Moving average 4 months: 155K
-> Moving average 5 months: 164K
-> Moving average 6 months: 160K
 
- Also, as pointed out by the Fed members during the last Fed Minutes, qualitative indicators, namely the number of long-term unemployed (more than 27 weeks), the number of full-time jobs or the “underemployment rate”, are only improving slightly. Similarly, the decline in the unemployment rate is mainly explained by a fall of participation rate (lowest since Aug 1978) which is not a good thing.
 
6/ The Syrian conflict could create uncertainty to the extent that the debt ceiling has not been raised. The fact is that military action could increase  public spending above expectations and therefore could reduce the time remaining to politicians to find a compromise. Currently, according to Treasury Secretary, the deadline sould be reached by mid-October.
 
7/ During the G20, IMF noted that currently emerging economies are seen as particularly vulnerable to a tightening of US monetary policy and  recommended that policy makers be ready to handle a rise in financial instability. In this context, Fed could choose to give more time to other policy markers.
 
8/ Fed communaction: The Fed members have not yet defined criteria or thresholds which would impact the asset purchase program.
 
- Moreover, since last FOMC, almost all members (voters and non-voters) have instisted on the fact that “tapering” will be only dependent on data which were clearly weaker than expected. The last Beige Book comfirms that activity continued to expand at a modest to moderate pace during the reporting period of early July through late August.
 
- Finally, some people forget that voters are more “dovish” that non-voters and that they give less press interviews.
 
- All Fed members’ speeches concerning QE and economic activity since the last FOMC meeting (July 30-31) are available here.

NABE Economists Do Not Expect “Tapering” in September

Contrary to the Bloomberg consensus, the NABE (National Association of Business Economists) survey shows that most economists do not expect the Fed to “taper” in September.

 

More from Bloomberg:

 

The Fed will reduce its monthly bond purchases from $85 billion at its next meeting on Sept. 17-18, according to 65 percent of economists in an Aug. 9-13 Bloomberg survey. The median estimate is for a cut to $75 billion each month.

 

More from WSJ:

 

Most economists say the Federal Reserve won’t begin scaling back its bond-buying program until later in the fall or early next year, according to a National Association for Business Economics survey released Monday.
 
The economists appear to be more cautious in their outlook than Wall Street banks and even some Fed officials that have looked to the central bank’s September 17-18 meeting as a point to begin easing the pace of bond purchases, currently at $85 billion a month.
 
Only 10% of 220 economists polled expect the wind down to start before the end of September. The survey found 39% expect the first tapering of purchases in the final three months of 2013 with the remainder saying the Fed will hold off at least until 2014.

 

This survey was unveiled while several Fed members gave their opinions last Friday about reducing the asset purchases program. All believe that currently, there is not enough data to make a tapering decision in September. San Francisco Fed President John Williams (non-voter) and St. Louis Fed President James Bullard (voter) seem to favor “tapering” later this year. However, Atlanta Fed President Dennis Lockhart (non-voter) could support September if data continue to point toward a sustainable improvement (growth and employment).

 

My view
 
I still believe that Fed will not begin to reduce its asset purchase program in September because:
 
- Since few days, excluding Dallas Fed President Richard Fisher, Fed non-voters, who are more hawkish than voters, have become more cautious concerning the need for “tapering” in September and could be disappointed by economic data.
 
- Indeed, despite some improvement in Europe and China, the latest US figures for July and August were disappointing and confirmed that growth forecasts published by Fed in June are not reachable. Moreover, investors begin to have concerns regarding the impact of higher mortgage rates to the extent that new home sales fell significantly in July.
 
Moreover, as Lockhart noted it, a difficult political situation in Washington in the fall could be a blow to confidence.