“I think the December 2008 FOMC decision unwittingly committed the U.S. to an extremely long period at the zero lower bound similar to the situation in Japan, with unknown consequences for the macroeconomy,” Bullard said. Pointing to the Bank of Japan’s long struggle against deflation and slow growth, Bullard said he has seen “no evidence” that a faster economic recovery results from quickly lowering interest rates to near zero.

Seems to me the Fed is making an all out effort to push back on the higher longer term rates, particularly mortgage rates. However, at least so far those rates remain elevated and at least so far mortgage purchase applications remain down year over year.

Again, seems to me it comes down to the notion that if forward guidance works to firm the economy, rates will move higher/sooner than if it doesn’t work to firm the economy.

This means forward guidance works to bring long rates down only if markets don’t believe it helps the economy.

So what’s a Fed to do to bring long rates down?
Seems to me the only tool left is unconditional guidance or purchasing securities on a price basis, rather than a quantity basis. Which does of course work, to the basis point.

That is, if the Fed announced it had a 2% bid for unlimited quantities of 10 year notes they would not trade higher than 2% while that bid was active. My recollection was that this was done during WWII.

And that we didn’t lose.
;)

Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate.

Hence the conundrum. On the one hand policy should cause lower rates, but it should also promote the higher rates of growth and inflation desired by the Fed, which in turn would trigger a ‘removal of accommodation’/rate hikes that much sooner than if the QE hadn’t been conducted.

Problem is the private sector is path dependent/pro cyclical. When sales slow incomes slow sales slow, employment slows, etc. etc.

Govt can be/is counter cyclical. When sales slow tax payments fall and unemployment comp. rises, etc. etc. AKA ‘automatic fiscal stabilizers.’

This cycle’s prior slowdowns had a safety net of govt deficit spending of near 10% of GDP, then a year or so later maybe 7%, etc. As the automatic fiscal stabilizers cut back that govt support with the modest recovery raising tax liabilities and cutting transfer payments.

But today, after this year’s proactive deficit reduction measures, we’ve gapped down to maybe a 3% deficit for ‘support’ when things slow. And it feels to me like the demand leakages have begun ‘winning’ when govt proactively stepped back to ‘make room for the private sector’.

What that actually means is the private sector now must (deficit) spend increasingly more than its income on goods and services to offset those agents spending less than their incomes (demand leakages), or the output doesn’t get sold. By identity. To the penny.

Well, sure doesn’t look like it’s going to come from housing. And while cars remain up some it’s not nearly enough. And capex isn’t coming through as hoped for and as needed to fill the spending gap left by the govt cutbacks. And the 126,000 print for NFP private sector job growth fits the same narrative as well- no top line growth = no job/income growth, etc.

Not to mention QE and low rates in general from the Fed remain a source of drag via the interest income channel, and all as Congress continues to fight for bragging rights with regard to deficit reduction.

It’s all nothing that a big fat tax cut and/or spending increase wouldn’t reverse, of course, as the slow motion train wreck continues.

So imagine you are a moderate FOMC member.

Mortgage apps are down, new home sales marginal, and private sector job creation sagging. And you keep revising your GDP forecast lower at each meeting. Likewise inflation remains low, and you believe the risks are asymmetrical. That is, you know you can stop inflation and growth with rate hikes, but you’re not so sure about fighting deflation.

And so, as an FOMC member, you’d like to see mortgage rates back down. So how do you get them there? You might not like QE, and at least highly suspect it doesn’t have any first order effects, and you fear there are unknown costs, but you know tapering, for whatever reason- almost to the point the reason doesn’t matter- causes rates to go higher. And you know not tapering brought them down some, but not enough. Fed funds are already close to 0% so there’s no room there. Forward guidance, etc. has kept the short end low but not the long end. You are afraid to simply peg long rates with an unlimited bid for securities at your target rate. You know a weaker economic forecast will bring long rates down but that it would be intellectually dishonest to manipulate a forecast.

And maybe worst of all, if you do something that causes markets to believe the economy will do a lot better, mortgage rates go higher, presuming Fed rate hikes will accompany growth, and thereby make things worse instead of better.

Seems the A students know it’s just a tax.

That leaves the Fed in a very bad place. They are utilizing a tool, QE, that only works to bring down rates if markets believe it doesn’t actually work to help the economy.

That is, if markets believe QE is good for the economy, they will price in Fed rate hikes that much sooner, keeping mortgage rates high.

And if they think QE is bad for the economy, they will price in lower rates down the road, which brings mortgage rates lower.

So if the Fed wants lower rates, they know that more QE will only bring rates down if markets think it doesn’t help the economy.

Fed’s Bernanke focused on whether bond-buying works, Fisher says

By Ann Saphir

October 4 (Reuters) — The Federal Reserve’s powerful chairman and architect of the U.S. central bank’s massive bond-buying program is serious about questioning its effectiveness, a Fed policymaker known for his opposition to the program said on Thursday.

“The difference I have with my colleagues is the question of efficacy,” Richard Fisher, president of the Dallas Federal Reserve Bank, told a group of CEOs in Little Rock, Arkansas. “To his great credit, Chairman Bernanke has made this the driving point of every discussion: Is this working or is it not working?”

Fisher, repeating comments he made just hours earlier in his hometown of Dallas, said he believes it is not.

The Fed, he said, has done enough, and it is up to Congress to create tax and regulatory certainty so that businesses feel comfortable hiring again.

“I am not alone” at the Fed in doubting the program’s effectiveness, he said.

Looks to me like there’s been more push back on rates due to risks to housing, perceived to be the most rate sensitive ‘engine of growth’. I don’t think this Fed wants its legacy to be ‘just when things got going after 5 years of hard work the let rates go up and it all went bad again.’

The problem is that if markets believe these Fed tools do work to support higher rates of growth than otherwise, that means Fed rate hikes will actually be sooner/faster etc. which works to keep rates higher. So seems it’s a bit of a conundrum. The policy designed to keep term rates down can instead work to keep them higher.

And should the stock market ‘crater’, the Fed will likely look to ‘do more’ which could be anything from ‘more of same’- more QE, guidance, tolerances, etc- to outright rate caps, which are the only ‘reliable’ way to set lower term rates.

*FED’S WILLIAMS: AFTER FIRST RATE HIKE, ONLY GRADUAL INCREASES

*WILLIAMS SAYS UNEMPLOYMENT IS TOO HIGH, INFLATION TOO LOW

*FED’S WILLIAMS SEES UNCONVENTIONAL STIMULUS FOR NEXT FEW YEARS

*FED’S WILLIAMS: AFTER FIRST RATE HIKE, ONLY GRADUAL INCREASES

*WILLIAMS HAS SUPPORTED RECORD MONETARY POLICY STIMULUS

*WILLIAMS DOESN’T VOTE ON MONETARY POLICY THIS YEAR

*SAN FRANCISCO FED PRESIDENT JOHN WILLIAMS SPEAKS IN SAN DIEGO

*WILLIAMS SAYS UNEMPLOYMENT IS TOO HIGH, INFLATION TOO LOW

*FED’S WILLIAMS SEES UNCONVENTIONAL STIMULUS FOR NEXT FEW YEARS

Here’s my take on the Volcker article

My comments in below:

The Fed & Big Banking at the Crossroads

By Paul Volcker

I have been struck by parallels between the challenges facing the Federal Reserve today and those when I first entered the Federal Reserve System as a neophyte economist in 1949.

Most striking then, as now, was the commitment of the Federal Reserve, which was and is a formally independent body, to maintaining a pattern of very low interest rates, ranging from near zero to 2.5 percent or less for Treasury bonds. If you feel a bit impatient about the prevailing rates, quite understandably so, recall that the earlier episode lasted fifteen years.

The initial steps taken in the midst of the depression of the 1930s to support the economy by keeping interest rates low were made at the Fed’s initiative. The pattern was held through World War II in explicit agreement with the Treasury. Then it persisted right in the face of double-digit inflation after the war, increasingly under Treasury and presidential pressure to keep rates low.

Yes, and this was done after conversion to gold was suspended which made it possible. And they fixed long rates as well/

The growing restiveness of the Federal Reserve was reflected in testimony by Marriner Eccles in 1948:

Under the circumstances that now exist the Federal Reserve System is the greatest potential agent of inflation that man could possibly contrive.
This was pretty strong language by a sitting Fed governor and a long-serving board chairman. But it was then a fact that there were many doubts about whether the formality of the independent legal status of the central bank—guaranteed since it was created in 1913—could or should be sustained against Treasury and presidential importuning. At the time, the influential Hoover Commission on government reorganization itself expressed strong doubts about the Fed’s independence. In these years calls for freeing the market and letting the Fed’s interest rates rise met strong resistance from the government.

Not freeing the ‘market’ but letting the Fed chair have his way. Rates would be set ‘politically’ either way. Just a matter of who.

Treasury debt had enormously increased during World War II, exceeding 100 percent of the GDP, so there was concern about an intolerable impact on the budget if interest rates rose strongly. Moreover, if the Fed permitted higher interest rates this might lead to panicky and speculative reactions. Declines in bond prices, which would fall as interest rates rose, would drain bank capital. Main-line economists, and the Fed itself, worried that a sudden rise in interest rates could put the economy back in recession.

All of those concerns are in play today, some sixty years later, even if few now take the extreme view of the first report of the then new Council of Economic Advisers in 1948: “low interest rates at all times and under all conditions, even during inflation,” it said, would be desirable to promote investment and economic progress. Not exactly a robust defense of the Federal Reserve and independent monetary policy.

But in my humble opinion a true statement!

Eventually, the Federal Reserve did get restless, and finally in 1951 it rejected overt presidential pressure to maintain a ceiling on long-term Treasury rates. In the event, the ending of that ceiling, called the “peg,” was not dramatic. Interest rates did rise over time, but with markets habituated for years to a low interest rate, the price of long-term bonds remained at moderate levels. Monetary policy, free to act against incipient inflationary tendencies, contributed to fifteen years of stability in prices, accompanied by strong economic growth and high employment. The recessions were short and mild.

I agreed with John Kenneth Galbraith in that inflation was not a function of rates, at least not in the direction they believed, due to interest income channels. However, the rate caps on bank deposits, etc. Did mean that rate hikes had the potential to disrupt those financial institutions and cut into lending, until those caps were removed.

In general, however, the ‘business cycle’ issues are better traced to fiscal balance.

No doubt, the challenge today of orderly withdrawal from the Fed’s broader regime of “quantitative easing”—a regime aimed at stimulating the economy by large-scale buying of government and other securities on the market—is far more complicated. The still-growing size and composition of the Fed’s balance sheet imply the need for, at the least, an extended period of “disengagement,” i.e., less active purchasing of bonds so as to keep interest rates artificially low.

Artificially? vs what ‘market signals’? Rates are ‘naturally’ market determined with fixed fx policies, not today’s floating fx.

In fact, without govt ‘interference’ such as interest on reserves and tsy secs, the ‘natural’ rate is 0 as long as there are net reserve balances from deficit spending.

Nor is there any technical or operational reason for unwinding QE. Functionally, the Fed buying securities is identical to the tsy not issuing them and instead letting its net spending remain as reserve balances. Either way deficit spending results in balances in reserve accounts rather than balances in securities accounts. And in any case both are just dollar balances in Fed accounts.

Moreover, the extraordinary commitment of Federal Reserve resources,

‘Resources’? What does that mean? Crediting an account on its own books is somehow ‘using up a resource’? It’s just accounting information!

alongside other instruments of government intervention, is now dominating the largest sector of our capital markets, that for residential mortgages. Indeed, it is not an exaggeration to note that the Federal Reserve, with assets of $3.5 trillion and growing, is, in effect, acting as the world’s largest financial intermediator. It is acquiring long-term obligations in the form of bonds and financing those purchases by short-term deposits. It is aided and abetted in doing so by its unique privilege to create its own liabilities.

The Fed creates govt liabilities, aka making payments. That’s its function. And, for example, the treasury securities are the initial intervention. They are paid for by the Fed debiting reserve accounts and crediting securities accounts. All QE does is reverse that as the Fed debits the securities accounts and ‘recredits’ the reserve accounts. So it can be said that all QE does is neutralize prior govt intervention.

The beneficial effects of the actual and potential monetizing of public and private debt, which is the essence of the quantitative easing program, appear limited and diminishing over time. The old “pushing on a string” analogy is relevant. The risks of encouraging speculative distortions and the inflationary potential of the current approach plainly deserve attention.

Right, with the primary fundamental effect being the removal of interest income from the economy. The Fed turned over some $100billion to the tsy that the economy would have otherwise earned. QE is a tax on the economy.

All of this has given rise to debate within the Federal Reserve itself. In that debate, I trust that sight is not lost of the merits—economic and political—of an ultimate return to a more orthodox central banking approach. Concerning possible changes in Fed policy, it is worth quoting from Fed Chairman Ben Bernanke’s remarks on June 19:

Going forward, the economic outcomes that the Committee sees as most likely involve continuing gains in labor markets, supported by moderate growth that picks up over the next several quarters as the near-term restraint from fiscal policy and other headwinds diminishes. We also see inflation moving back toward our 2 percent objective over time.

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 [asset] purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear.

In this scenario, when asset purchases ultimately come to an end, the unemployment rate would likely be in the vicinity of 7 percent, with solid economic growth supporting further job gains, a substantial improvement from the 8.1 percent unemployment rate that prevailed when the Committee announced this program.

I would like to emphasize once more the point that our policy is in no way predetermined and will depend on the incoming data and the evolution of the outlook as well as on the cumulative progress toward our objectives. If conditions improve faster than expected, the pace of asset purchases could be reduced somewhat more quickly. If the outlook becomes less favorable, on the other hand, or if financial conditions are judged to be inconsistent with further progress in the labor markets, reductions in the pace of purchases could be delayed.

Indeed, should it be needed, the Committee would be prepared to employ all of its tools, including an increase in the pace of purchases for a time, to promote a return to maximum employment in a context of price stability.

Implying QE works to do that.

I do not doubt the ability and understanding of Chairman Bernanke and his colleagues. They have a considerable range of instruments available to them to manage the transition, including the novel approach of paying interest on banks’ excess reserves, potentially sterilizing their monetary impact.

Reserves can be thought of as ‘one day treasury securities’ and the idea that paying interest sterilizing anything is a throwback to fixed fx policy, not applicable to floating fx.

What is at issue—what is always at issue—is a matter of good judgment, leadership, and institutional backbone. A willingness to act with conviction in the face of predictable political opposition and substantive debate is, as always, a requisite part of a central bank’s DNA.

A good working knowledge of monetary operations would be a refreshing change as well!

Those are not qualities that can be learned from textbooks. Abstract economic modeling and the endless regression analyses of econometricians will be of little help. The new approach of “behavioral” economics itself is recognition of the limitations of mathematical approaches, but that new “science” is in its infancy.

Monetary operations can be learned from money and banking texts.

A reading of history may be more relevant. Here and elsewhere, the temptation has been strong to wait and see before acting to remove stimulus and then moving toward restraint. Too often, the result is to be too late, to fail to appreciate growing imbalances and inflationary pressures before they are well ingrained.

Those who know monetary operations read history very differently from those who have it wrong.

There is something else that is at stake beyond the necessary mechanics and timely action. The credibility of the Federal Reserve, its commitment to maintaining price stability, and its ability to stand up against partisan political pressures are critical. Independence can’t just be a slogan. Nor does the language of the Federal Reserve Act itself assure protection, as was demonstrated in the period after World War II. Then, the law and its protections seemed clear, but it was the Treasury that for a long time called the tune.

And didn’t do a worse job.

In the last analysis, independence rests on perceptions of high competence, of unquestioned integrity, of broad experience, of nonconflicted judgment and the will to act. Clear lines of accountability to Congress and the public will need to be honored.

And a good working knowledge of monetary operations.

Moreover, maintenance of independence in a democratic society ultimately depends on something beyond those institutional qualities. The Federal Reserve—any central bank—should not be asked to do too much, to undertake responsibilities that it cannot reasonably meet with the appropriately limited powers provided.

I know that it is fashionable to talk about a “dual mandate”—the claim that the Fed’s policy should be directed toward the two objectives of price stability and full employment. Fashionable or not, I find that mandate both operationally confusing and ultimately illusory. It is operationally confusing in breeding incessant debate in the Fed and the markets about which way policy should lean month-to-month or quarter-to-quarter with minute inspection of every passing statistic. It is illusory in the sense that it implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel Prize winners but by experience.

The Federal Reserve, after all, has only one basic instrument so far as economic management is concerned—managing the supply of money and liquidity.

Completely wrong. With floating fx, it can only set rates. It’s always about price, not quantity.

Asked to do too much—for example, to accommodate misguided fiscal policies, to deal with structural imbalances, or to square continuously the hypothetical circles of stability, growth, and full employment—it will inevitably fall short. If in the process of trying it loses sight of its basic responsibility for price stability, a matter that is within its range of influence, then those other goals will be beyond reach.

Back in the 1950s, after the Federal Reserve finally regained its operational independence, it also decided to confine its open market operations almost entirely to the short-term money markets—the so-called “Bills Only Doctrine.” A period of remarkable economic success ensued, with fiscal and monetary policies reasonably in sync, contributing to a combination of relatively low interest rates, strong growth, and price stability.

Yes, and the price of oil was fixed by the Texas railroad commission at about $3 where it remained until the excess capacity in the US was gone and the Saudis took over that price setting role in the early 70′s.

That success faded as the Vietnam War intensified, and as monetary and fiscal restraints were imposed too late and too little. The absence of enough monetary discipline in the face of the overt inflationary pressures of the war left us with a distasteful combination of both price and economic instability right through the 1970s—a combination not inconsequentially complicated further by recurrent weakness in the dollar.

No mention of a foreign ‘monopolist’ hiking crude prices from 3 to 40?

Or of Carter’s deregulation of nat gas in 78 causing OPEC to drown in excess capacity in the early 80′s?

Or the non sensical targeting of borrowed reserves that worked only to shift rate control from the FOMC to the NY fed desk, and prolonged the inflation even as oil prices collapsed?

We cannot “go home again,” not to the simpler days of the 1950s and 1960s. Markets and institutions are much larger, far more complex. They have also proved to be more fragile, potentially subject to large destabilizing swings in behavior. There is the rise of “shadow banking”—the nonbank intermediaries such as investment banks, hedge funds, and other institutions overlapping commercial banking activities.

Not to mention restaurants letting people eat before they pay for their meals. This completely misses the mark.

Partly as a result, there is the relative decline of regulated commercial banks, and the rapid innovation of new instruments such as derivatives. All these have challenged both central banks and other regulatory authorities around the developed world. But the simple logic remains; and it is, in fact, reinforced by these developments. The basic responsibility of a central bank is to maintain reasonable price stability—and by extension to concern itself with the stability of financial markets generally.

In my judgment, those functions are complementary and should be doable.

They are, but it all requires an understanding of the underlying monetary operations.

I happen to believe it is neither necessary nor desirable to try to pin down the objective of price stability by setting out a single highly specific target or target zone for a particular measure of prices. After all, some fluctuations in prices, even as reflected in broad indices, are part of a well-functioning market economy. The point is that no single index can fully capture reality, and the natural process of recurrent growth and slowdowns in the economy will usually be reflected in price movements.

With or without a numerical target, broad responsibility for price stability over time does not imply an inability to conduct ordinary countercyclical policies. Indeed, in my judgment, confidence in the ability and commitment of the Federal Reserve (or any central bank) to maintain price stability over time is precisely what makes it possible to act aggressively in supplying liquidity in recessions or when the economy is in a prolonged period of growth but well below its potential.

With floating fx bank liquidity is always infinite. That’s what deposit insurance is all about.
Again, this makes central banking about price and not quantity.

–

Feel free to distribute.

Core PCE Y/Y:

Personal Consumption SAAR:

Real GDP Y/Y:

Pending Home Sales:

So we know QE is about signaling.

And the Fed knew that tapering was a signal they were ok with the higher rates, including the already higher mortgage rates.

And they decided they didn’t want to send that signal, so they delayed the taper. They also revised down their growth forecasts, which meant the economy was performing at less than expected levels, which further pushed back against the higher rates.

And they expressed risk of continued ‘fiscal drag’ as well. It’s all about signaling their current reaction function to control the term structure of rates. And in fact the rates in question have subsequently come down, indicating tactical success. And, at least for now, the dollar is down a touch as well.

A few interesting things are not part of the discussion:

The Fed can directly set the term structure of their risk free rates by simply making a locked market on any part of the curve.

The Fed buying tsy secs is functionally the same as the tsy not issuing them in the first place.

The consequences of QE/tapering are largely the same as the issuance/non issuance of tsy secs.

Interest rate tools, operationally, also include the tsy issuing only at pre determined rates and maturities, as well as buy backs and maturity swaps.

And why is the paradox of thrift, a mainstream standard for maybe 200 years, never discussed?

By identity, if govt cuts back on its net spending, that output only gets sold if some other agent increases its net spending.

Meanwhile, the demand leakages continue to grow relentlessly. It’s all implicit in every mainstream model, but none the less left out of every public discussion.

And there’s another issue that’s internally conflicted. The Fed believes inflation is about monetary policy and the Fed, and not fiscal policy and the treasury. Hike rates until the ‘real rate’ is high enough and inflation goes down, because it makes borrowing expensive and slows the economy as well.

And lower the real rate enough and inflation goes up, though unfortunately that pesky 0 bound limits that tool, resulting in a hand off to QE and forward guidance and expanding the types of assets the Fed buys and the like.

Not to mention the key is the inflation expectations channel, which rules all, of course.

Let me conclude that today most mainstream elites have recognized there is no solvency risk for the US govt. Simplistically, ‘they can always print the money’ which is good enough for the point at hand. So with no solvency risk, the risk of too high deficits comes down to inflation, and there are no credible long term inflation forecasts flashing red.

Additionally, the Fed believes inflation is a monetary and not fiscal phenomenon. So the Fed can’t even argue against deficits on inflationary grounds, leaving it with, for all practical purposes, no argument for deficit reduction.

So as we enter the fray over deficit reduction and the risk of catastrophic systemic failure, there is no intellectual leadership coming from the Fed, and an intellectually dishonest silence from the mainstream academic and media elite.

Good luck to us!

(feel free to distribute)

Not tapering and all that goes with that can be called their push back vs higher mtg rates, in that tapering would have signaled they were ok with the higher rates.

A close ally of Fed Chairman Ben Bernanke, Dudley highlighted the drags from the sharp recent rise in longer-term interest rates, higher taxes and lower public spending adopted earlier this year, and questions over the U.S. debt limit and government funding as Congress meets this autumn.

Dudley also said the Fed could “wait a long time” to raise interest rates once the unemployment rate hits a 6.5 percent threshold.

Atlanta Fed boss Dennis Lockhart said the labor market still needed a spark to continue its recovery, Dow Jones reported.

“We see a picture in which fewer firms are expanding employment, and each expanding firm is adding fewer new jobs on average than in the past,” Lockhart said, according to a report, adding that the “employment dynamics of the U.S. economy are slower.”

I propose they produce 2 forecasts.

One that assumes ‘appropriate monetary policy’ and one that assumes interest rates are left unchanged.
;)

Mtg rates are up by over a full 1%, because the Fed may scale back on QE. But it hasn’t scaled back yet. But rates are way higher anyway.

So the question is, does QE per se keep down rates?
Or does it just about signals?

So when this last round of QE began, why did rates go down? It couldn’t have been just because the Fed was going to buy, which would then drive rates down, because it’s now already bought, and will continue to buy, yet rates are suddenly far higher.

Nor did rates fall with QE because market participants though it would make the economy worse?

It’s about rates falling on the belief that Fed buying per se would bring them down, and now rates are higher on the belief that the Fed not buying as much means rates go higher. Even though it’s been demonstrated that the amount or pace of Fed buying per say doesn’t do that.

There is no way to make any sense out of it.
It’s just knee jerk reactions in a sea of ignorance.

Yes, though August is subject to revision, and the underlying ‘private payroll’ growth, which lags fiscal adjustments, is now looking like it’s been hurt by the year end tax hikes and subsequent sequesters.

Yes

Yes, though Friday’s +.1 for personal income is more ‘macro’

Ok, fewer jobs but more spread out.

Yes, as it looks like un and under employed are transitioning to ‘out of the labor force’, and participation rates are falling for younger people as well and if you say half the drop in participation is cyclical you can add about 4% to the un and under employment rates.

Agreed. The Fed is heck bent on tapering. They don’t like QE as a tool. And Jackson Hole had presentations showing it doesn’t work with regards to output, employment, CPI, etc.

And the term structure of rates was lower, questioning what QE actually accomplishes in that regard, as it’s still going full force at the moment.

New Fed Chair

Confirmation is another story, of course. But seems his odds of confirmation should be better than, say, Jamie Dimon… ;)

From DB,
Comments below:

Commentary for friday: the second print on Q2 GDP growth showed a significant upward revision to +2.5% from +1.7% as previously reported. Recall that growth was only +1.1% in Q1.

After the 3rd downward revision

Given that the deflator was revised a tenth higher (0.8% vs. 0.7% as previously reported), the magnitude of the overall revision is even more impressive. Personal consumption was unrevised at +1.8% in Q2,

Down from 2.3% in Q1 if I recall correctly

While business fixed investment was only modestly softer (+4.4% vs. +4.6%). Residential investment was also reduced slightly (+12.9% vs. +13.4%). The big changes to Q2 growth were in inventories and international trade. Inventory accumulation was lifted to $62.6b from $56.7b as first reported, thereby adding 0.6 ppt to growth compared to 0.4 ppt previously.

The question is voluntary to restock from a Q1 dip or sales growth forecast, or involuntary due to lower than expected sales.

In terms of trade, firmer exports and softer imports drove net exports to improve; as a result, the original -0.8 ppt drag from trade was revised up to zero.

Question is whether exports can be sustained through Q3 as the dollar spike vs Japan and then the EM’s hurts ‘competitiveness’

The government drag on Q2 was revised to become slightly larger (-0.2 ppt vs. -0.1 ppt as first reported). Nonetheless, the federal government drag on economic activity has diminished significantly compared to the impact in Q1 (-0.7 ppt) and Q4 2012 (-1.2 ppt). A diminished drag from the public sector should enable overall GDP growth, which was +1.6% year-on-year in Q2, to close the gap with private sector growth, which was +2.5% over the same period.

I see it this way- the govt deficit spending is a net add of spending/income. So with the deficit dropping from 7% of GDP last year to maybe 3% currently, with maybe 2% of the drop from proactive fiscal initiatives, some other agent has to be spending more than his income to sustain sales/incomes etc. If not, output goes unsold/rising inventories and then unproduced. The needed spending to ‘fill the spending gap’ left by govt cutbacks can come from either domestic credit expansion or increased net exports (no resident credit expansion/savings reductions. I don’t detect the domestic credit expansion and net export growth/trade deficit reduction seems likely given the dollar spike and oil price spike?

If we achieve +3.0% growth in the current quarter and +3.5% in Q4, this will push the year-on-year rate to +1.7% in Q3 and +2.5% by yearend. (this is in line with the Fed’s central tendency forecasts, which are due to be updated at the september FOMC meeting.)

In order for our growth forecast to come to fruition, we will need to see a pickup in consumer spending,

Hard to fathom, as personal consumption has been slipping from 2.3 in Q1 to 1.8 in Q2, and walmart and the like sure aren’t seeing any material uptick in sales? Car sales are ok, but further gains from the June high rate seems doubtful as July has already posted a slower annual rate.

homebuilding and business investment relative to first half performance. The first two series are likely to be boosted by sturdier employment gains, and hence faster household income growth.

Seems early Q3 reports show falling mtg purchase applications, home sales falling month to month, and lots of anecdotals showing the spike in mtg rates has slowed things down. So growth from Q2 seems unlikely at this point?

We are confident that the pace of hiring will pick up in the relatively near term, because jobless claims continue to hold near cyclical lows.

New jobs dropped to 160,000 in july, and claims measure people losing their jobs, not new hires. Also, top line growth, the ultimate driver of employment, remains low, so assuming actual productivity hasn’t gone negative a spike in jobs is unlikely?

Given the usefulness of jobless claims as a payroll forecasting tool, it should come as little surprise that they are also significantly correlated with wage and salary growth. In fact, over the past 25 years, the current level of jobless claims has typically coincided with private wage and salary growth above 6% compared to 3.8% in Q2.

As above, claims may have correlated with all that in the past, but the causation isn’t there. Looks to me like claims are more associated with ‘time from the bottom’ as with time after the economy bottoms firings tend to slow, regardless of hiring?

Meanwhile, the third growth driver noted above—business investment—will largely depend on the corporate profit trend. Yesterday’s second print on GDP provided the first look at economy-wide corporate profits, which rose +3.9% in Q2 vs. -1.3% in Q1. Many analysts fretted the decline in profits in Q1, because they tend to drive business investment and hiring plans. We dismissed the Q1 weakness as a temporary development which occurred in lagged response to the growth slowdown in Q4 2012 and Q1 2013. The fact that profits are reaccelerating (+5.0% year-on-year versus +2.1% in Q1) is an encouraging development in this regard.

Profits also are a function of sales, which are a function of ‘deficit spending’ from either govt or other sectors, as previously discussed. And, again, i see no signs of ‘leaping ahead’ in any of those sectors.

Faster GDP growth through yearend should result in even stronger corporate profit growth.

Agreed! But didn’t he just say that the GDP growth would come from business investment that’s a function of profits (and in turn a function of sales/GDP)?

To be sure, the additional growth momentum now evident in the Q2 GDP results makes our 3% target for current quarter growth more easily attainable. –CR

I don’t see how inventory growth is ‘momentum’ and seems there are severe headwinds to Q3 net exports as drivers of growth?

And govt is there with a deficit of only 3% of GDP to help offset the relentless ‘unspent income’/demand leakages inherent in the global institutional structure.

This shows what’s happened to the number of home mortgage purchase applications since rates went up (they’ve gone down!).

While higher rates help savers as much as they hurt borrowers, the borrowing at the higher rates has to take place for the savers to get helped.

Yes, Tsy auction rates are higher, but the Fed is buying pretty much the same amount of securities that the Tsy is selling, so no help there.

It’s when the economy is ‘strong enough’ such that borrowing continues even at the higher rates that those rates ‘feed back into the economy’ through savers.

However, it is now the case that ‘investors’ hiked mtg rates due to various Fed fears, etc. with the open question being whether or not prospective home buyers will in fact borrow at those rates. If they don’t, no savers get helped and housing adds less to GDP.

Meanwhile, the Fed wants to exit QE on it’s ‘risk/reward’ analysis and has stated that improvement in the ‘labor market’ is what warrants the exit. And if ‘market forces’ have moved rates higher due to the economic outlook that’s ok too, so the current level of rates and weaker housing is unlikely to alter tapering plans, leaving the coming August jobs report as the critical data point. At the same time, the Fed wants to remain highly ‘accommodative’ and so will likely take communicative measures to attempt to keep longer rates lower, as they seem to have run out of operational alternatives.

So in my search for the agents who will increase their ‘borrowing to spend’ sufficiently to offset this year’s decrease in the govt’s deficit spending, seems I can scratch off ‘housing’.

And if any of you notice any signs of ‘borrowing to spend’ I’m missing please let me know- it’s lonely (and depressing!) being the only one to see the kind of downside risk to GDP growth I’m seeing…

Stocks up a tad on the news. So apparently improved odds of not tapering continues to outweigh a weaker economic outlook. Just as what seemed to be an improving economic outlook was out weighed by consequently higher odds of tapering.

Ironically, of course, QE is largely a placebo, merely shifting indifference levels to where the economy holds more $ in reserve accounts at the Fed and fewer $ in securities accounts at the Fed, a pretty much meaningless distinction, apart from the maybe $100 billion per year of interest income the Fed turns over treasury that would have been earned by the economy, etc.

But markets apparently remain in a now inapplicable ‘gold standard paradigm’ where $ in reserve accounts were convertible into gold, rising gold outflows, devaluation/default, etc. and thus fear some sort of undefinable imagined ‘negative consequences’ of QE. And this includes at least substantial segments of the Fed’s open market committee, not to mention pretty much everyone at Jackson Hole, which is pretty much everyone.

And in a ‘good is bad and bad is good’ out of paradigm world, the awakening can be most rude.

If growth is decelerating as I fear because deficits are too small, and stocks rally because they believe that’s all trumped by more QE, the analogy that comes to mind is a giant central Florida sink hole.

Meanwhile, the euro zone is double vulnerable. It’s also sitting on a growing, giant sink hole, where a softening in net exports to a softening US could be the catalyst for implosion.

US we have a problem, and its name is durable goods

By Bob Pisani

Aug 26 (CNBC) — U.S. durable goods have sent a shudder through the market, after July’s headline number checked in much weaker than expected, down a whopping 7.3 percent versus expectations of a 4 percent decline.

Even the much-parsed ex-transportation figure came in far below expectations with a 6.7 percent plunge. Excluding defense and air, the core number was down 3.3 percent, after four consecutive up months.

You can’t even blame it on seasonality or some statistical fluke. This was the most high profile data point this week, and the result greatly complicates the taper talk.

The pressure is really on the nonfarm payroll report for August, due next week. You really need a strong number for the Fed to even flirt with scaling back its bond purchases in September. Consensus for nonfarm payrolls is around 166,000, but that number needs to be really strong —arguably over 200,000.

Something you can show those who claim the Fed is independent, etc.:

“You have to remember that we are a legal creature of Congress and that we only have a mandate to concern ourselves with the interest of the United States,” Dennis Lockhart, president of the Atlanta Fed, told Bloomberg Television’s Michael McKee. “Other countries simply have to take that as a reality and adjust to us if that’s something important for their economies.”

Comments in below and highlights mine:

Developments in Financial Markets and the Federal Reserve’s Balance Sheet
The Manager of the System Open Market Account reported on developments in domestic and foreign financial markets as well as the System open market operations during the period since the Federal Open Market Committee (FOMC) met on June 18-19, 2013. By unanimous vote, the Committee ratified the Open Market Desk’s domestic transactions over the intermeeting period. There were no intervention operations in foreign currencies for the System’s account over the intermeeting period.

In support of the Committee’s longer-run planning for improvements in the implementation of monetary policy, the Desk report also included a briefing on the potential for establishing a fixed-rate, full-allotment overnight reverse repurchase agreement facility as an additional tool for managing money market interest rates. The presentation suggested that such a facility would allow the Committee to offer an overnight, risk-free instrument directly to a relatively wide range of market participants, perhaps complementing the payment of interest on excess reserves held by banks and thereby improving the Committee’s ability to keep short-term market rates at levels that it deems appropriate to achieve its macroeconomic objectives. The staff also identified several key issues that would require consideration in the design of such a facility, including the choice of the appropriate facility interest rate and possible additions to the range of eligible counterparties. In general, meeting participants indicated that they thought such a facility could prove helpful; they asked the staff to undertake further work to examine how it might operate and how it might affect short-term funding markets. A number of them emphasized that their interest in having the staff conduct additional research reflected an ongoing effort to improve the technical execution of policy and did not signal any change in the Committee’s views about policy going forward.

This would tend to work against the larger banks to the extent larger depositors could access the Fed directly.

Staff Review of the Economic Situation
The information reviewed for the July 30-31 meeting indicated that economic activity expanded at a modest pace in the first half of the year. Private-sector employment increased further in June, but the unemployment rate was still elevated. Consumer price inflation slowed markedly in the second quarter, likely restrained in part by some transitory factors, but measures of longer-term inflation expectations remained stable. The Bureau of Economic Analysis (BEA) released its advance estimate for second-quarter real gross domestic product (GDP), along with revised data for earlier periods, during the second day of the FOMC meeting. The staff’s assessment of economic activity and inflation in the first half of 2013, based on information available before the meeting began, was broadly consistent with the new information from the BEA.

Modest growth and inflation low and stable.

Private nonfarm employment rose at a solid pace in June, as in recent months, while total government employment decreased further. The unemployment rate was 7.6 percent in June, little changed from its level in the prior few months. The labor force participation rate rose slightly, as did the employment-to-population ratio. The rate of long-duration unemployment decreased somewhat, but the share of workers employed part time for economic reasons moved up; both of these measures remained relatively high. Forward-looking indicators of labor market activity in the near term were mixed: Although household expectations for the labor market situation generally improved and firms’ hiring plans moved up, initial claims for unemployment insurance were essentially flat over the intermeeting period, and measures of job openings and the rate of gross private-sector hiring were little changed.

Manufacturing production expanded in June, and the rate of manufacturing capacity utilization edged up. Auto production and sales were near pre-recession levels, and automakers’ schedules indicated that the rate of motor vehicle assemblies would continue at a similar pace in the coming months. Broader indicators of manufacturing production, such as the readings on new orders from the national and regional manufacturing surveys, were generally consistent with further modest gains in factory output in the near term.

Real personal consumption expenditures (PCE) increased more slowly in the second quarter than in the first. However, some key factors that tend to support household spending were more positive in recent months; in particular, gains in equity values and home prices boosted household net worth, and consumer sentiment in the Thomson Reuters/University of Michigan Surveys of Consumers rose in July to its highest level since the onset of the recession.

Slower PCE increase and stocks and the Michigan survey mentioned subsequently reversed some.

Conditions in the housing sector generally improved further, as real expenditures for residential investment continued to expand briskly in the second quarter. However, construction activity was still at a low level, with demand restrained in part by tight credit standards for mortgage loans. Starts of new single-family homes were essentially flat in June, but the level of permit issuance was consistent with gains in construction in subsequent months. In the multifamily sector, where activity is more variable, starts and permits both decreased. Home prices continued to rise strongly through May, and sales of both new and existing homes increased, on balance, in May and June. The recent rise in mortgage rates did not yet appear to have had an adverse effect on housing activity.

Subsequently mortgage apps continued to fall as rates rose.

Growth in real private investment in equipment and intellectual property products was greater in the second quarter than in the first quarter.2 Nominal new orders for nondefense capital goods excluding aircraft continued to trend up in May and June and were running above the level of shipments. Other recent forward-looking indicators, such as surveys of business conditions and capital spending plans, were mixed and pointed to modest gains in business equipment spending in the near term. Real business expenditures for nonresidential construction increased in the second quarter after falling in the first quarter. Business inventories in most industries appeared to be broadly aligned with sales in recent months.

Real federal government purchases contracted less in the second quarter than in the first quarter as reductions in defense spending slowed. Real state and local government purchases were little changed in the second quarter; the payrolls of these governments expanded somewhat, but state and local construction expenditures continued to decrease.

Didn’t mention tax collections were up.

The U.S. international trade deficit widened in May as exports fell slightly and imports rose. The decline in exports was led by a sizable drop in consumer goods, while most other categories of exports showed modest gains. Imports increased in a wide range of categories, with particular strength in oil, consumer goods, and automotive products.

Exports subsequently firmed some.

Overall U.S. consumer prices, as measured by the PCE price index, were unchanged from the first quarter to the second and were about 1 percent higher than a year earlier. Consumer energy prices declined significantly in the second quarter, although retail gasoline prices, measured on a seasonally adjusted basis, moved up in June and July. The PCE price index for items excluding food and energy rose at a subdued rate in the second quarter and was around 1-1/4 percent higher than a year earlier. Near-term inflation expectations from the Michigan survey were little changed in June and July, as were longer-term inflation expectations, which remained within the narrow range seen in recent years. Measures of labor compensation indicated that gains in nominal wages and employee benefits remained modest.

Inflation remained low.

Foreign economic growth appeared to remain subdued in comparison with longer-run trends. Nonetheless, there were some signs of improvement in the advanced foreign economies. Production and business confidence turned up in Japan, real GDP growth picked up to a moderate pace in the second quarter in the United Kingdom, and recent indicators suggested that the euro-area recession might be nearing an end. In contrast, Chinese real GDP growth moderated in the first half of this year compared with 2012, and indicators for other emerging market economies (EMEs) also pointed to less-robust growth. Foreign inflation generally remained well contained. Monetary policy stayed highly accommodative in the advanced foreign economies, but some EME central banks tightened policy in reaction to capital outflows and to concerns about inflationary pressures from currency depreciation.

Not much prospect for meaningful export growth.

Staff Review of the Financial Situation
Financial markets were volatile at times during the intermeeting period as investors reacted to Federal Reserve communications and to incoming economic data and as market dynamics appeared to amplify some asset price moves. Broad equity price indexes ended the period higher, and longer-term interest rates rose significantly. Sizable increases in rates occurred following the June FOMC meeting, as investors reportedly saw Committee communications as suggesting a less accommodative stance of monetary policy than had been expected going forward; however, a portion of the increases was reversed as subsequent policy communications lowered these concerns. U.S. economic data, particularly the June employment report, also contributed to the rise in yields over the period.

Stocks down, term interest rates higher, job growth a bit lower subsequently.

On balance, yields on intermediate- and longer-term Treasury securities rose about 30 to 45 basis points since the June FOMC meeting, with staff models attributing most of the increase to a rise in term premiums and the remainder to an upward revision in the expected path of short-term rates. The federal funds rate path implied by financial market quotes steepened slightly, on net, but the results from the Desk’s July survey of primary dealers showed little change in dealers’ views of the most likely timing of the first increase in the federal funds rate target. Market-based measures of inflation compensation were about unchanged.

Over the period, rates on primary mortgages and yields on agency mortgage-backed securities (MBS) rose about in line with the 10-year Treasury yield. The option-adjusted spread for production-coupon MBS widened somewhat, possibly reflecting a downward revision in investors’ expectations for Federal Reserve MBS purchases, an increase in uncertainty about longer-term interest rates, and convexity-related MBS selling.

Spreads between yields on 10-year nonfinancial corporate bonds and yields on Treasury securities narrowed somewhat on net. Early in the period, yields on corporate bonds increased, and bond mutual funds and bond exchange-traded funds experienced large net redemptions in June; the rate of redemptions then slowed in July.

Market sentiment toward large domestic banking organizations appeared to improve somewhat over the intermeeting period, as the largest banks reported second-quarter earnings that were above analysts’ expectations. Stock prices of large domestic banks outperformed broader equity indexes, and credit default swap spreads for the largest bank holding companies moved about in line with trends in broad credit indexes.

Municipal bond yields rose sharply over the intermeeting period, increasing somewhat more than yields on Treasury securities. In June, gross issuance of long-term municipal bonds remained solid and was split roughly evenly between refunding and new-capital issuance. The City of Detroit’s bankruptcy filing reportedly had only a limited effect on the market for municipal securities as it had been widely anticipated by market participants.

Credit flows to nonfinancial businesses showed mixed changes. Reflecting the reduced incentive to refinance as longer-term interest rates rose, the pace of gross issuance of investment- and speculative-grade corporate bonds dropped in June and July, compared with the elevated pace earlier this year. In contrast, gross issuance of equity by nonfinancial firms maintained its recent strength in June. Leveraged loan issuance also continued to be strong amid demand for floating-rate instruments by investors. Financing conditions for commercial real estate continued to recover slowly. In response to the July Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), banks generally indicated that they had eased standards on both commercial and industrial (C&I) and commercial real estate loans over the past three months. For C&I loans, standards were currently reported to be somewhat easy compared with longer-term norms, while for commercial real estate loans, standards remained somewhat tighter than longer-term norms. Banks reported somewhat stronger demand for most types of loans.

Financing conditions in the household sector improved further in recent months. Mortgage purchase applications declined modestly through July even as refinancing applications fell off sharply with the rise in mortgage rates. The outstanding amounts of student and auto loans continued to expand at a robust pace in May. Credit card debt remained about flat on a year-over-year basis. In the July SLOOS, banks reported that they had eased standards on most categories of loans to households in the second quarter, but that standards on all types of mortgages, and especially on subprime mortgage loans and home equity lines of credit, remained tight when judged against longer-run norms.

Mortgage purchase applications subsequently continued to fall as rates rose.

Increases in total bank credit slowed in the second quarter, as the book value of securities holdings fell slightly and C&I loan balances at large banks increased only modestly in April and May. M2 grew at an annual rate of about 7 percent in June and July, supported by flows into liquid deposits and retail money market funds. Both of these components of M2 may have been boosted recently by the sizable redemptions from bond mutual funds. The monetary base continued to expand rapidly in June and July, driven mainly by the increase in reserve balances resulting from the Federal Reserve’s asset purchases.

Ten-year sovereign yields in the United Kingdom and Germany rose with U.S. yields early in the intermeeting period but fell back somewhat after statements by the European Central Bank and the Bank of England were both interpreted by market participants as signaling that their policy rates would be kept low for a considerable time. On net, the U.K. 10-year sovereign yield increased, though by less than the comparable yield in the United States, while the yield on German bunds was little changed. Peripheral euro-area sovereign spreads over German bunds were also little changed on net. Japanese government bond yields were relatively stable over the period, after experiencing substantial volatility in May. The staff’s broad nominal dollar index moved up as the dollar appreciated against the currencies of the advanced foreign economies, consistent with the larger increase in U.S. interest rates. The dollar was mixed against the EME currencies. Foreign equity prices generally increased, although equity prices in China declined amid investor concerns regarding further signs that the economy was slowing and over volatility in Chinese interbank funding markets. Outflows from EME equity and bond funds, which had been particularly rapid in June, moderated in July.

Staff Economic Outlook
The data received since the forecast was prepared for the previous FOMC meeting suggested that real GDP growth was weaker, on net, in the first half of the year than had been anticipated. Nevertheless, the staff still expected that real GDP would accelerate in the second half of the year. Part of this projected increase in the rate of real GDP growth reflected the staff’s expectation that the drag on economic growth from fiscal policy would be smaller in the second half as the pace of reductions in federal government purchases slowed and as the restraint on growth in consumer spending stemming from the higher taxes put in place at the beginning of the year diminished. For the year as a whole, the staff anticipated that the rate of growth of real GDP would only slightly exceed that of potential output. The staff’s projection for real GDP growth over the medium term was essentially unrevised, as higher equity prices were seen as offsetting the restrictive effects of the increase in longer-term interest rates. The staff continued to forecast that the rate of real GDP growth would strengthen in 2014 and 2015, supported by a further easing in the effects of fiscal policy restraint on economic growth, increases in consumer and business confidence, additional improvements in credit availability, and accommodative monetary policy. The expansion in economic activity was anticipated to lead to a slow reduction in the slack in labor and product markets over the projection period, and the unemployment rate was expected to decline gradually.

The staff’s forecast for inflation was little changed from the projection prepared for the previous FOMC meeting. The staff continued to judge that much of the recent softness in consumer price inflation would be transitory and that inflation would pick up somewhat in the second half of this year. With longer-run inflation expectations assumed to remain stable, changes in commodity and import prices expected to be modest, and significant resource slack persisting over the forecast period, inflation was forecast to be subdued through 2015.

The staff continued to see numerous risks around the forecast. Among the downside risks for economic activity were the uncertain effects and future course of fiscal policy, the possibility of adverse developments in foreign economies, and concerns about the ability of the U.S. economy to weather potential future adverse shocks. The most salient risk for the inflation outlook was that the recent softness in inflation would not abate as anticipated.

Participants’ Views on Current Conditions and the Economic Outlook
In their discussion of the economic situation, meeting participants noted that incoming information on economic activity was mixed. Household spending and business fixed investment continued to advance, and the housing sector was strengthening. Private domestic final demand continued to increase in the face of tighter federal fiscal policy this year, but several participants pointed to evidence suggesting that fiscal policy had restrained spending in the first half of the year more than they previously thought. Perhaps partly for that reason, a number of participants indicated that growth in economic activity during the first half of this year was somewhat below their earlier expectations. In addition, subpar economic activity abroad was a negative factor for export growth. Conditions in the labor market improved further as private payrolls rose at a solid pace in June, but the unemployment rate remained elevated. Inflation continued to run below the Committee’s longer-run objective.

Participants generally continued to anticipate that the growth of real GDP would pick up somewhat in the second half of 2013 and strengthen further thereafter. Factors cited as likely to support a pickup in economic activity included highly accommodative monetary policy, improving credit availability, receding effects of fiscal restraint, continued strength in housing and auto sales, and improvements in household and business balance sheets. A number of participants indicated, however, that they were somewhat less confident about a near-term pickup in economic growth than they had been in June; factors cited in this regard included recent increases in mortgage rates, higher oil prices, slow growth in key U.S. export markets, and the possibility that fiscal restraint might not lessen.

Consumer spending continued to advance, but spending on items other than motor vehicles was relatively soft. Recent high readings on consumer confidence and boosts to household wealth from increased equity and real estate prices suggested that consumer spending would gather momentum in the second half of the year. However, a few participants expressed concern that higher household wealth might not translate into greater consumer spending, cautioning that household income growth remained slow, that households might not treat the additions to wealth arising from recent equity price increases as lasting, or that households’ scope to extract housing equity for the purpose of increasing their expenditures was less than in the past.

The housing sector continued to pick up, as indicated by increases in house prices, low inventories of homes for sale, and strong demand for construction. While recent mortgage rate increases might serve to restrain housing activity, several participants expressed confidence that the housing recovery would be resilient in the face of the higher rates, variously citing pent-up housing demand, banks’ increasing willingness to make mortgage loans, strong consumer confidence, still-low real interest rates, and expectations of continuing rises in house prices. Nonetheless, refinancing activity was down sharply, and the incoming data would need to be watched carefully for signs of a greater-than-anticipated effect of higher mortgage rates on housing activity more broadly.

Subsequently mtg purchase apps fell further and there has been anecdotal evidence of mortgage originators cutting staff, while homebuilder confidence has continues to firm.

In the business sector, the outlook still appeared to be mixed. Manufacturing activity was reported to have picked up in a number of Districts, and activity in the energy sector remained at a high level. Although a step-up in business investment was likely to be a necessary element of the projected pickup in economic growth, reports from businesses ranged from those contacts who expressed heightened optimism to those who suggested that little acceleration was likely in the second half of the year.

Participants reported further signs that the tightening in federal fiscal policy restrained economic activity in the first half of the year: Cuts in government purchases and grants reportedly had been a factor contributing to slower growth in sales and equipment orders in some parts of the country, and consumer spending seemed to have been held back by tax increases. Moreover, uncertainty about the effects of the federal spending sequestration and related furloughs clouded the outlook. It was noted, however, that fiscal restriction by state and local governments seemed to be easing.

No mention of increased state and loval tax collection.

The June employment report showed continued solid gains in payrolls. Nonetheless, the unemployment rate remained elevated, and the continuing low readings on the participation rate and the employment-to-population ratio, together with a high incidence of workers being employed part time for economic reasons, were generally seen as indicating that overall labor market conditions remained weak. It was noted that employment growth had been stronger than would have been expected given the recent pace of output growth, reflecting weak gains in productivity. Some participants pointed out that once productivity growth picked up, faster economic growth would be required to support further increases in employment along the lines seen of late. However, one participant thought that sluggish productivity performance was likely to persist, implying that the recent pace of output growth would be sufficient to maintain employment gains near current rates.

Recent readings on inflation were below the Committee’s longer-run objective of 2 percent, in part reflecting transitory factors, and participants expressed a range of views about how soon inflation would return to 2 percent. A few participants, who felt that the recent low inflation rates were unlikely to persist or that the low PCE inflation readings might be marked up in future data revisions, suggested that, as transitory factors receded and the pace of recovery improved, inflation could be expected to return to 2 percent reasonably quickly. A number of others, however, viewed the low inflation readings as largely reflecting persistently deficient aggregate demand, implying that inflation could remain below 2 percent for a protracted period and further supporting the case for highly accommodative monetary policy.

Both domestic and foreign asset markets were volatile at times during the intermeeting period, reacting to policy communications and data releases. In discussing the increases in U.S. longer-term interest rates that occurred in the wake of the June FOMC meeting and the associated press conference, meeting participants pointed to heightened financial market uncertainty about the path of monetary policy and a shift of market expectations toward less policy accommodation. A few participants suggested that this shift occurred in part because Committee participants’ economic projections, released following the June meeting, generally showed a somewhat more favorable outlook than those of private forecasters, or because the June policy statement and press conference were seen as indicating relatively little concern about inflation readings, which had been low and declining. Moreover, investors may have perceived that Committee communications about the possibility of slowing the pace of asset purchases also implied a higher probability of an earlier firming of the federal funds rate. Subsequent Federal Reserve communications, which emphasized that decisions about the two policy tools were distinct and underscored that a highly accommodative stance of monetary policy would remain appropriate for a considerable period after purchases are completed, were seen as having helped clarify the Committee’s policy strategy. A number of participants mentioned that, by the end of the intermeeting period, market expectations of the future course of monetary policy, both with regard to asset purchases and with regard to the path of the federal funds rate, appeared well aligned with their own expectations. Nonetheless, some participants felt that, as a result of recent financial market developments, overall financial market conditions had tightened significantly, importantly reflecting larger term premiums, and they expressed concern that the higher level of longer-term interest rates could be a significant factor holding back spending and economic growth. Several others, however, judged that the rise in rates was likely to exert relatively little restraint, or that the increase in equity prices and easing in bank lending standards would largely offset the effects of the rise in longer-term interest rates. Some participants also stated that financial developments during the intermeeting period might have helped put the financial system on a more sustainable footing, insofar as those developments were associated with an unwinding of unsustainable speculative positions or an increase in term premiums from extraordinarily low levels.

Equities are subsequently down substantially.

In looking ahead, meeting participants commented on several considerations pertaining to the course of monetary policy. First, almost all participants confirmed that they were broadly comfortable with the characterization of the contingent outlook for asset purchases that was presented in the June post meeting press conference and in the July monetary policy testimony. Under that outlook, if economic conditions improved broadly as expected, the Committee would moderate the pace of its securities purchases later this year. And if economic conditions continued to develop broadly as anticipated, the Committee would reduce the pace of purchases in measured steps and conclude the purchase program around the middle of 2014. At that point, if the economy evolved along the lines anticipated, the recovery would have gained further momentum, unemployment would be in the vicinity of 7 percent, and inflation would be moving toward the Committee’s 2 percent objective. While participants viewed the future path of purchases as contingent on economic and financial developments, one participant indicated discomfort with the contingent plan on the grounds that the references to specific dates could be misinterpreted by the public as suggesting that the purchase program would be wound down on a more-or-less preset schedule rather than in a manner dependent on the state of the economy. Generally, however, participants were satisfied that investors had come to understand the data-dependent nature of the Committee’s thinking about asset purchases. A few participants, while comfortable with the plan, stressed the need to avoid putting too much emphasis on the 7 percent value for the unemployment rate, which they saw only as illustrative of conditions that could obtain at the time when the asset purchases are completed.

Second, participants considered whether it would be desirable to include in the Committee’s policy statement additional information regarding the Committee’s contingent outlook for asset purchases. Most participants saw the provision of such information, which would reaffirm the contingent outlook presented following the June meeting, as potentially useful; however, many also saw possible difficulties, such as the challenge of conveying the desired information succinctly and with adequate nuance, and the associated risk of again raising uncertainty about the Committee’s policy intentions. A few participants saw other forms of communication as better suited for this purpose. Several participants favored including such additional information in the policy statement to be released following the current meeting; several others indicated that providing such information would be most useful when the time came for the Committee to begin reducing the pace of its securities purchases, reasoning that earlier inclusion might trigger an unintended tightening of financial conditions.

Finally, the potential for clarifying or strengthening the Committee’s forward guidance for the federal funds rate was discussed. In general, there was support for maintaining the current numerical thresholds in the forward guidance. A few participants expressed concern that a decision to lower the unemployment threshold could potentially lead the public to view the unemployment threshold as a policy variable that could not only be moved down but also up, thereby calling into question the credibility of the thresholds and undermining their effectiveness. Nonetheless, several participants were willing to contemplate lowering the unemployment threshold if additional accommodation were to become necessary or if the Committee wanted to adjust the mix of policy tools used to provide the appropriate level of accommodation. A number of participants also remarked on the possible usefulness of providing additional information on the Committee’s intentions regarding adjustments to the federal funds rate after the 6-1/2 percent unemployment rate threshold was reached, in order to strengthen or clarify the Committee’s forward guidance. One participant suggested that the Committee could announce an additional, lower set of thresholds for inflation and unemployment; another indicated that the Committee could provide guidance stating that it would not raise its target for the federal funds rate if the inflation rate was expected to run below a given level at a specific horizon. The latter enhancement to the forward guidance might be seen as reinforcing the message that the Committee was willing to defend its longer-term inflation goal from below as well as from above.

Committee Policy Action
Committee members viewed the information received over the intermeeting period as suggesting that economic activity expanded at a modest pace during the first half of the year. Labor market conditions showed further improvement in recent months, on balance, but the unemployment rate remained elevated. Household spending and business fixed investment advanced, and the housing sector was strengthening, but mortgage rates had risen somewhat and fiscal policy was restraining economic growth. The Committee expected that, with appropriate policy accommodation, economic growth would pick up from its recent pace, resulting in a gradual decline in the unemployment rate toward levels consistent with the Committee’s dual mandate. With economic activity and employment continuing to grow despite tighter fiscal policy, and with global financial conditions less strained overall, members generally continued to see the downside risks to the outlook for the economy and the labor market as having diminished since last fall. Inflation was running below the Committee’s longer-run objective, partly reflecting transitory influences, but longer-run inflation expectations were stable, and the Committee anticipated that inflation would move back toward its 2 percent objective over the medium term. Members recognized, however, that inflation persistently below the Committee’s 2 percent objective could pose risks to economic performance.

In their discussion of monetary policy for the period ahead, members judged that a highly accommodative stance of monetary policy was warranted in order to foster a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability. In considering the likely path for the Committee’s asset purchases, members discussed the degree of improvement in the labor market outlook since the purchase program began last fall. The unemployment rate had declined considerably since then, and recent gains in payroll employment had been solid. However, other measures of labor utilization–including the labor force participation rate and the numbers of discouraged workers and those working part time for economic reasons–suggested more modest improvement, and other indicators of labor demand, such as rates of hiring and quits, remained low. While a range of views were expressed regarding the cumulative improvement in the labor market since last fall, almost all Committee members agreed that a change in the purchase program was not yet appropriate. However, in the view of the one member who dissented from the policy statement, the improvement in the labor market was an important reason for calling for a more explicit statement from the Committee that asset purchases would be reduced in the near future. A few members emphasized the importance of being patient and evaluating additional information on the economy before deciding on any changes to the pace of asset purchases. At the same time, a few others pointed to the contingent plan that had been articulated on behalf of the Committee the previous month, and suggested that it might soon be time to slow somewhat the pace of purchases as outlined in that plan. At the conclusion of its discussion, the Committee decided to continue adding policy accommodation by purchasing additional MBS at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month and to maintain its existing reinvestment policies. In addition, the Committee reaffirmed its intention to keep the target federal funds rate at 0 to 1/4 percent and retained its forward guidance that it anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored.

Members also discussed the wording of the policy statement to be issued following the meeting. In addition to updating its description of the state of the economy, the Committee decided to underline its concern about recent shortfalls of inflation from its longer-run goal by including in the statement an indication that it recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, while also noting that it continues to anticipate that inflation will move back toward its objective over the medium term. The Committee also considered whether to add more information concerning the contingent outlook for asset purchases to the policy statement, but judged that doing so might prompt an unwarranted shift in market expectations regarding asset purchases. The Committee decided to indicate in the statement that it “reaffirmed its view”–rather than simply “expects”–that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens.

At the conclusion of the discussion, the Committee voted to authorize and direct the Federal Reserve Bank of New York, until it was instructed otherwise, to execute transactions in the System Account in accordance with the following domestic policy directive:

“Consistent with its statutory mandate, the Federal Open Market Committee seeks monetary and financial conditions that will foster maximum employment and price stability. In particular, the Committee seeks conditions in reserve markets consistent with federal funds trading in a range from 0 to 1/4 percent. The Committee directs the Desk to undertake open market operations as necessary to maintain such conditions. The Desk is directed to continue purchasing longer-term Treasury securities at a pace of about $45 billion per month and to continue purchasing agency mortgage-backed securities at a pace of about $40 billion per month. The Committee also directs the Desk to engage in dollar roll and coupon swap transactions as necessary to facilitate settlement of the Federal Reserve’s agency mortgage-backed securities transactions. The Committee directs the Desk to maintain its policy of rolling over maturing Treasury securities into new issues and its policy of reinvesting principal payments on all agency debt and agency mortgage-backed securities in agency mortgage-backed securities. The System Open Market Account Manager and the Secretary will keep the Committee informed of ongoing developments regarding the System’s balance sheet that could affect the attainment over time of the Committee’s objectives of maximum employment and price stability.”

The vote encompassed approval of the statement below to be released at 2:00 p.m.:

“Information received since the Federal Open Market Committee met in June suggests that economic activity expanded at a modest pace during the first half of the year. Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated. Household spending and business fixed investment advanced, and the housing sector has been strengthening, but mortgage rates have risen somewhat and fiscal policy is restraining economic growth. Partly reflecting transitory influences, inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate. The Committee sees the downside risks to the outlook for the economy and the labor market as having diminished since the fall. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, but it anticipates that inflation will move back toward its objective over the medium term.

To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. Taken together, these actions should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.

The Committee will closely monitor incoming information on economic and financial developments in coming months. The Committee will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes. In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens. In particular, the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. In determining how long to maintain a highly accommodative stance of monetary policy, the Committee will also consider other information, including additional measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent.”

Voting for this action: Ben Bernanke, William C. Dudley, James Bullard, Elizabeth Duke, Charles L. Evans, Jerome H. Powell, Sarah Bloom Raskin, Eric Rosengren, Jeremy C. Stein, Daniel K. Tarullo, and Janet L. Yellen.

Voting against this action: Esther L. George.

Ms. George dissented because she favored including in the policy statement a more explicit signal that the pace of the Committee’s asset purchases would be reduced in the near term. She expressed concerns about the open-ended approach to asset purchases and viewed providing such a signal as important at this time, in light of the ongoing improvement in labor market conditions as well as the potential costs and uncertain benefits of large-scale asset purchases.

It was agreed that the next meeting of the Committee would be held on Tuesday-Wednesday, September 17-18, 2013. The meeting adjourned at 12:30 p.m. on July 31, 2013.

Notation Vote
By notation vote completed on July 9, 2013, the Committee unanimously approved the minutes of the FOMC meeting held on June 18-19, 2013

While the Fed believes labor markets have improved sufficiently to start somehow unwinding QE, they have made it clear the data and their forecasts are not going to trigger any actual Fed rate hikes anytime soon. For one thing there is currently no sign of any kind of developing private sector credit expansion that would cause them to immediately hike rates to ‘cool down’. In fact, at this point they are keeping rate policy arguably ‘as accommodative as possible’ to remain supportive of private credit expansion.

On the other hand, the ‘markets’ have become concerned about ‘supply side’ effects of ‘tapering’, fearing fewer Fed purchases will mean higher term rates, and particularly higher mortgage rates, even as the Fed funds rate remains well anchored at current levels.

So what we are seeing is a ‘market determined’ decision to hike longer term rates based mainly on supply fears and not on fears of ‘excess demand’ driving up rates.

And adding to the volatility is the notion that should the Fed someday decide things have ‘normalized’ and the economy no longer ‘needs’ negative real rates,
that would translate into the Fed shifting the Fed funds rate to maybe 3-4% to be at some ‘neutral’ spread to ‘inflation’ etc.

So it’s pretty much binary- we stay near 0 (life support) until it’s time to ‘normalize’ to 3-4%.

All of this makes it rational for market indifference levels to shift a full 1% or more-turning term financing on or off- on nuances of Fed language.

All of which comes back to the fact that the term structure of risk free rates, with floating fx, is necessarily a policy decision, best left to political decision vs market decision, because with floating fx ‘market decision’ is necessarily nothing more than forecasting reaction functions of those setting the rates. That is, the ‘feedback’ from today’s rates determined by market forces is nothing more than what markets think the Fed will vote into policy down the road.

And I see no value in paying the real price of the volatility/uncertainty we are seeing to get that kind of information.

So best to cut the highly disruptive volatility that goes with letting markets determine longer term risk free rates by having the Fed peg the entire term structure of risk free rates with, for example, a bid for the entire tsy curve at their target rate ceiling, along with an open ended securities lending facility.

That is, in my humble opinion best for the FOMC to vote on the entire term structure of risk free rates than today’s policy of voting on just the Fed funds rate and using ‘language’ to influence the curve.

But that’s just me…

(feel free to distribute)