We’ve suggested that the Fed has drunken a bit too much of its own confidence Kool-Aid to be talking about tapering QE. The problem now, as we’ve stressed, is that the effect of QE may prove to be asymmetrical, that the flattening the yield curve exercise when short rates were already in ZIRP land haven’t done much to stimulate the real economy (where was the Fed in calling for more fiscal stimulus, or in arguing against deficit scare-mongering?). But perversely, taking it away could be more of an economic downer than the central bank anticipates. Mere talk of ending QE is tantamount to urging on a rate hike for the longer end of the yield curve. And higher rates there will not only prove to be a damper, but with economic growth slowing all over the world, has the potential to have knock-on effects.
Three front page stories at the Wall Street Journal tonight all highlight reasons why the Fed might dial down taper expectations.
The first is that mortgage refinancings have fallen, which we predicted would happen. Even though there is some whistling-in-the-dark talk about how some consumers might refinance with rates going in the wrong direction, the most you are likely to see is people who’ve been distracted and haven’t gotten around to doing the paperwork. Anyone who is remotely attentive to rates has likely refied multiple times already. Refis are a weak but real source of stimulus, since lower mortgage payments means more money in consumers’ pockets to spend on other stuff. So a big drop in rates takes that source of incremental spending away.
The second is on how the Fed-induced interest rate increases have led to worrisome interest rate increases in Eurozone periphery countries. Suddenly the belief that the Eurozone crisis was over is coming into question> From the Journal:
Government bonds have recently taken a hit around the world, now that investors are preparing for the possible end of central banks’ boundless economic stimulus. And those bonds of the weakest euro-zone countries have shown some of the biggest drops…
Yields on the 10-year Greek bond, which had strengthened remarkably since last summer, ended Thursday at 10.03%. That is two percentage points higher than where they stood on May 22, when the U.S. Federal Reserve signaled its giant bond-buying program might slow this year. At 6.47%, the Portuguese 10-year is more than one percentage point above its May low. Bond yields rise when their prices fall.
The 10-year Spanish bond, which was near 4% in early May, closed Thursday at 4.61%, flat on the day. The Italian 10-year, a hair stronger Thursday at 4.35%, also is off over the month. The spread—or the amount of additional yield investors demand, above that paid by benchmark Germany—also has risen for both countries over the period.
And the piece points out how putting these countries on the austerity rack is not going to improve their ability to make good on their obligations:
But a larger problem may be looming: In order to restore their economic viability, weaker countries must improve their industries’ competitiveness by pushing down wages and other costs, relative to Germany and other northern countries. But the German economy appears to have settled into a pattern of low growth and low inflation.
That means Italy, Spain and the others need more of this so-called internal devaluation. And devaluation makes it harder to pay down debt.
Some economist have question whether wages are even the source of the periphery countries’ woes. One line of thought is the simple, “you can’t starve labor and expect to have anyone to buy.” A second is that the periphery countries have the wrong industrial mix, and cutting wages won’t make enough of a dent in their competitiveness. They need to be in more value-added products (which is basically the approach taken by Mondragon, and the Basque region has much lower unemployment than the rest of Spain as a result).
The third article in the Journal addresses another topic near and dear to our heart, that inflation rates and inflation expectation are falling. The Fed has been taking the view that this is an aberration but if current patterns hold or intensify, it will have to rethink its assumptions. From the article:
The Fed has a 2% inflation goal and doesn’t want consumer prices to veer too much above or too much below that number over time. Some recent inflation measures have dropped below that level this year, but Fed officials haven’t been too worried because expectations of future inflation were stable….
“It is no longer clear that inflation expectations are so stable,” Jan Hatzius, chief economist at Goldman Sachs Group Inc., said in an interview. Market-based measures of inflation expectations are now on “the low side of comfortable.” In a note to clients June 10, he predicted that expectations of lower inflation are likely to make Fed officials less willing to pull back on the bond-buying programs out of fear it could destabilize those expectations about future inflation….
In that context, the Fed launched its bond-buying program to bolster economic growth by pushing down long-term interest rates and pushing up asset prices, hoping that would spur spending, hiring and investment. If officials believe the economy is on track to gain strength in coming months, they might start to reduce the size of the bond purchases. But if they thought low inflation and falling expectations signaled new weakness in the economy, they might want to continue the program at its current level for longer.
The Fed’s next pronouncement is late next week. It’s too bad no one is capable of Greenspanian obfuscation. I’m not much good as a Fedwatcher since I’m not good at identifying with their point of view. Logically, given the above, you’d expect the Fed to walk back the taper talk a bit. But they may believe more “we’re staying with the program” messaging is better for the confidence fairy.
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I have to question how much a stimulus to the economy mortgage refinancings have been for a few reasons:
-Borrower only gets a fraction of the profit/savings of therefinancing, with the bank/lender extracting/retaining part of the benefit for themselves
-Lender or those holding the mortages lose out on the income, resulting in lost income,consumption or possibly under-funding insurance or pension which would have to be made up with rising premiums etc
-That same borrower may have savings parked at a financial institution which is now getting less interest. For the consumer both long and short funds if the mortgage is smaller than their savings the decrease in rates is a negative.
While typically reductions in rates have been stimulative, this time may actually be different. Banks have passed on less of savings in rates to borrowers than in past years, and we are now at the zero bound, and it’s not clear the typical associations still apply.
“You can’t starve labor and expect anyone to buy.”
The valuation of the S&P 500 seems to be predicated on the contrary hypothesis.
Nah, the valuation of the S&P 500 doesn’t _engage_ with that hypothesis. Equities are in a speculative ramp-up driven by the Fed’s pixelated liquidity, and thus have nothing to to with demand, and very little to do even with dividends. If the escalator is going up, Big Money takes a ride; it’s pretty simple. The hard thing used to be go get the Fed to give them huge loans for free, but they’ve got that sewn up real good just right now . . . .
The Fed has painted itself into a corner. To gain the ability to provide support to the various markets the bank must withdraw it … even when there are severe consequences to doing so. This is the gist of Chairman Bernanke’s “tapering” remarks. Should markets stagger when monetary authorities are offering what is in effect unlimited credit at very low cost, there is are no additional remedies the authorities can effectively offer. The central bank must curtail its support now … so that it might be able to offer unlimited credit again in the (near) future.
The problem — as always — is, once on the credit treadmill, one can never step off. One is compelled to constantly borrow more to retire older loans as they fall due.
“The problem — as always — is, once on the credit treadmill, one can never step off.”
This is the problem. Also the later you try to get off the more difficult it is… literally could become a landmine.
Similar in nature to the problem faced by “Fraud” Raju of Satyam while fudging annual report, each time fudging gets more difficult..
The only solution is to get off asapelse you could get blown up. In this case either the Fed does not do it now and gets blown up later or get off the treadmill now and blow a bit of Wall Steet (me… not unhappy with that!). But basically Fed is now between a rock and hard place.
The whole world is calling a bond bubble right now. It’s simply _too easy_ of a call based on ZRP. This is why special attention needs to be paid to the context.
Bill Gross at PIMCO had an unusually intelligent take on the current state of things:
Bond markets can’t force rates up while Fed policy remains 0 without a whip back. It’s common sense, and Bill Gross is starting to “get it”. Where will inflation come from in a fiscal environment where the House refuses to spend a dollar more than planned in CR’s? If the dumb money wants to drive rates in bond markets up in the short-term, let them do so, but there’s no reason to think growth or inflation is coming and that Treasury rates will move accordingly. Gross has been dead wrong on key fundamentals in the past, but he’s finally on board with what makes the Treasury market tick.
Treasury rates could easily rise in the short-term (and they certainly have already), but absent any higher inflation or growth numbers, they can’t possibly be sustainablly higher than 2% on the 10-yrs. The arb opp alone will cause serious upward pressure on the 1, 2-yr which will pressure the longer-term yields too.
The Fed more powerful than the market.
That doesn’t cause problems for those in propaganda?
FOUR YEARS into a so-called “recovery” and even the mere MENTION of “tapering” the unprecedented level of monetary stimulus still being applied sends heads spinning (and markets tumbling).
Simply unbelievable.
Hey, it’s an emergency. We didn’t win WWII in a day, remember?
Oh wait, we won WWII in less than four years?
Oops.
“You can’t starve labor and expect anyone to buy.”
Henry Ford would have agreed.
If you were getting away with stealing trillions of dollars, would you want to stop anytime soon?
Here’s some further reading for the interested on Bernanke vs the Evans rule and the hawks: “Bernanke will want to soften, but he may be limited by the rest of the FOMC, as well as by the Evan’s rule”.
http://research.handelsbanken.se/Speakers-corner/Martin-Enlund/Ahead-of-the-Fed-Bernanke-will-want-to-soften-but-he-may-be-limited-by-the-rest-of-the-FOMC-as-well-as-by-the-Evans-rule/
Outcome will be very interesting. If the Fed dials down on its taper talk after fairly minor market moves (from a central banks point of view) they risk undermining their credibility. It may also be tricky to sound really dovish without altering the Evans rule. Furthermore, if you’re a hawk that’s concerned about frothy markets, the recent reaction ought to make you want to taper even more…. Just some fun thoughts!
Bernanake sure doesn’t have Mr. Bubbles skill at inflating the next bubble, but this last collapse has left the shepple pertty well sheared bare so I’m sure it’s much harder to do.
Long term he’s trying to slowly inflate his way out of this mess (which seems to be working), but this will cement the current wealth disparity as the new norm. I’m not sure this is a long term “stable” solution (especially since it looks just like where we were in 2007 except that 99% of us have crummier jobs), but I think it will give Ben and Obama enough time to get out of Dodge before the $hit hits the fan.
with the Fed’s multi-year policy of ZIRP and WAIF (War Against Income, Fixed), i’m beginning to come around to D. Stockman’s argument that all the Fed has succeeded in doing is transferring the traditional wealth opportunities of the prudent/savings sector over to the WS casino sector. what i can’t figure out is how the Fed can begin to redress the balance – even if it wanted to. IMHO the perturbations caused by *muttering* in public about “tapering” are a harbinger of more instability ahead.
It’s extremely frustrating that the stability of the real economy is hostage to the various enthusiasms and vapors of the fake economy built on making money from money alone. All of the people working in these so-called “markets” ought to go out and make an honest living somewhere by actually producing something.
If it’s time to pull the plug and trigger the trans-Atlantic banking system’s further consolidation, then the Fed will do what it is told. It’s really a big mistake assuming the Fed’s role is beneficent. The Fed is a tool of imperial finance, which over the entire course of my adult lifetime has been stacked with friends of a Venetian-modeled oligarchy promoting the destruction of the sovereign nation state. Today’s feckless U.S. political class overseeing a decimated physical economy exposes the present moment’s raw truth whose reality has everyone who’s anyone grasping at straws in vain hope fantasy can sustain those whose livelihoods have been consumed propagating a lie claiming to give substance to the wealth of nations. Trouble is the policy of “controlled disintegration”–a directive Volcker openly espoused–remains the underlying modus operandi of imperial finance from the Fed on down. Again, if it’s time to pull the plug, the Fed will do what it is told.