Category Archives: Inflation

Balance of risks revisited

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“I don’t think that’s fair because I don’t — again, I think I’ve been pretty clear in saying we have an economy in the US that is fundamentally healthy. I think the jobs numbers today showed an economy that is fundamentally healthy. We’ve got very strong demand outside of the US. We’ve got exports growing, employment strong, inflation is contained. There are some risks, and I’m focused on those risks. That’s my job, and the biggest risk we have is housing and housing is a big drag on our economy and still, we’re going through a turbulent time in the capital markets. That’s a risk so we’re focused on the risks, but let’s not forget that we have a healthy economy.”
-Paulson

Two days before the Fed meeting Paulson is making the case that the economy is strong and he says the risks are *his job* and not the Fed’s job. Also, he said we have a strong $ policy after being silent on that for several months or more. No cut in the fed funds rate Tuesday would support his statements.
This article is the consensus view that’s pricing in a 25 cut on Tuesday.

US Fed seems poised to lower interest rates again at its meeting Tuesday

By JEANNINE AVERSA updated 6:46 a.m. ET, Sun., Dec. 9, 2007 WASHINGTON

A lot has changed since the U.S. Federal Reserve hinted two months ago that it might be finished cutting interest rates for a while. Credit has become harder to obtain,

Not true per se. Some spreads have widened, but absolute levels for mortgages, for example, are lower, and good credits are getting LIBOR minus funding in the bond markets. Yes, funding is more difficult and more expensive for ‘Wall Street’, but ‘Main Street’ borrowing needs are being met at reasonable terms.

Wall Street has convulsed again,

Stocks are generally up recently, and up for the year.

and the housing slump has intensified.

Maybe modestly, with some indicators flat to higher. Prices down for the quarter but YoY prices still higher as reported by the two broader measures.

As a result, policymakers at the central bank now appear to have changed their minds about the need to drop interest rates again.

Yes, that’s the appearance as seen by the financial press. (I haven’t read it that way.)

The Fed had cut rates twice this year and officials suggested in October that might be enough to help the economy survive the credit and housing stress.

And immediately afterward in several speeches as fed officials attempted unsuccessfully to take the cut out of Jan FF futures.

Then the problems snowballed,

There were no ‘snowballing problems’ only some spread widening even as absolute rates were generally lower and LIBOR rates going up over the next ‘turn’ at year end.

leading Fed Chairman Ben Bernanke to signal that one more cut might be needed.

Again, that’s how the financial press heard him. They never even reported firm the firm talk on inflation risks becoming elevated. The attitude is anything the fed says about inflation is just talk they have to say and that they don’t mean and not worth reporting.

Analysts expect the Fed to trim its key rate, now at 4.5 percent, by one-quarter of a percentage point at the meeting Tuesday. Some even speculate about the possibility of a half-point cut.

Yes, that’s the consensus.

Banks, financial companies and other investors who made loans to people with spotty credit

and fraudulent applications

or put money into securities backed by those subprime mortgages have lost billions of dollars (euros). Investors in the U.S. and abroad have grown more wary of buying new debt, thereby aggravating the credit crunch.

Yes. But again, ‘Main Street’ still remains well funded at reasonable terms.

All this has added to the turmoil on Wall Street, and Bernanke and other Fed officials say they must take it into account when deciding their next move.

Yes. And the economic numbers have come in strong enough for markets to take up to 35 bp out of the Eurodollars and nearly eliminate pricing in a 50 cut in the last few trading days.

But does lowering rates mean the Fed essentially is bailing out investors or encouraging more sloppy decision-making? In other words, what exactly is the Fed’s job?

Bernanke and other Fed officials say it is to make policy that keeps the economy growing and inflation low, a stable climate that benefits individuals, businesses and investors. The Fed also has a responsibility to ensure the banking system is sound and financial markets run smoothly.

Yes, exactly.

“There is a link between Wall Street and Main Street. The Fed is taking the right actions, but they should be careful,” said Victor Li, an economics professor at the Villanova School of Business.

That implies the question is whether the ‘market functioning’ risk is higher than the inflation risk, which is what the fed was addressing with the last two cuts.

This time ‘market functioning’ risk rhetoric has taken a back seat to ‘economic weakness’ risk rhetoric.
One more story of note:

Fed’s Inflation Measure Says Rates Can’t Fall as Traders Expect

By Liz Capo McCormick and Sandra Hernandez

Dec. 10 (Bloomberg) — The key to whether the Federal Reserve continues to cut interest rates after this week may hang on the wall behind economist Brian Sack’s desk in Washington.

Sack, head of monetary and financial market analysis at the Fed in 2003 and 2004, uses a chart that plots forward rates measuring investor expectations for inflation in five years. The gauge is so accurate that Sack and his colleagues persuaded the central bank to use it to help set policy. The chart is autographed by former Fed Chairman Alan Greenspan.

Right now, it shows current Fed Chairman Ben S. Bernanke may have less room to lower borrowing costs than investors in Treasuries anticipate, potentially setting bondholders up for a fall. The expected inflation rate, which Sack says replicates what Fed officials use, reached 2.91 percent last week, the highest since 2004, when the central bank began the first of an unprecedented 17 rate increases. The measure was at 2.79 percent on Nov. 1.

“One of the defining features of the Bernanke Fed to date is its emphasis on measures of longer-term inflation expectations,” said Sack, whose partners at Macroeconomic Advisors include former Fed Governor Laurence Meyer. “The Fed is willing to tolerate short-run movements in inflation, but only as long as those movements don’t appear to be dislodging long-run inflation expectations.”

Any evidence that accelerating inflation is becoming entrenched may heighten the Fed’s debate as policy makers consider cutting rates to keep the worst housing market in 16 years and mounting losses in securities related to subprime mortgages from tipping the economy into recession.

`Inflationary Pressures’

The gauge used by Sack, dubbed the five-year five-year forward breakeven inflation rate, suggests bets on lower Fed funds rates may be too bold.

Sack and other analysts derive the measure of inflation expectations from yields on five- and 10-year Treasury Inflation Protected Securities and Treasuries.

Five-year TIPS yield 2.15 percentage points less than five- year notes. This so-called breakeven rate is the average inflation rate investors expect over the next five years. The forward rate projects what the breakeven will be in five years, smoothing blips in inflation expectations from swings in oil prices or other events.

The five-year TIPS’ breakeven rate rose to a six-month high of 2.47 percent Nov. 27, the week after oil climbed to a record $99.29 a barrel, from about 1.9 percent on Aug. 31. As crude fell to a six-week low on Dec. 6, the breakeven rate declined and Sack’s measure dropped to 2.85 percent.

Bernanke mentioned the forward rate in a 2004 speech. Simon Kwan, a vice president at the San Francisco Fed, singled out the measure in a 2005 report, saying it “captures the market’s assessment of how well the Federal Reserve promotes price stability in the long run.”

Gaining Steam

Most analysts expect the economy to gain steam through 2008. Growth will slow to 1.5 percent this quarter from a 4.9 percent annual rate last quarter, and rise to 2.6 percent by 2009, according to the median forecast in a Bloomberg survey from Nov. 1 to Nov. 8.

The dollar, which is poised to depreciate against the euro for a second straight year, is also fueling inflation concerns. The currency’s drop and oil’s climb pushed import prices up 1.8 percent in October, the most in 17 months.

The government may say this week that consumer prices, which set TIPS rates, increased 4.1 percent last month from this year’s low of 2 percent in August and the biggest rise since July 2006, according to the median estimate of 19 economists. Food, imports and energy prices may raise inflation expectations, Bernanke said in a Nov. 30 speech in Charlotte, North Carolina.

To contact the reporter on this story:
Liz Capo McCormick in New York at Emccormick7@bloomberg.net ;
Sandra Hernandez in New York at shernandez4@bloomberg.net .

Last Updated: December 9, 2007 10:58 EST

‘The numbers’ could be used to support most anything the fed might do.The inflation numbers are both more than strong enough to support a hike, with CPI due to be reported north of 4.1 on December 14, and core moving up out of ‘comfort zones’ as well, not to mention ‘prices paid’ surveys higher and higher import and export with the weak $. Add to that the recent strong economic data – employment, CEO survey, and even car sales up a tad, etc. etc.

Inflation can also be dismissed as ‘only food and energy’ and due to fall based on (misreading) future prices as predictors of where prices will be, leaving the door open to cuts due to both ‘market functioning’ as justified by FF/LIBOR spreads at year end and the possibility of Wall Street spilling over to Main Street by ‘forward looking models’.

I can see the fed meeting going around in circles and it will come down to whether they care about inflation or not. Most of the financial community thinks they don’t, and they may be correct.

I think they do care, and care a lot, but that fear of ‘market functioning’ was severe enough to temporarily overcome their perceived imperative to sustain and environment of low inflation. And at the October meeting, the fear of some members has subsided enough to report a dissenting vote, along with half the regional banks voting against a cut.

I do think that if the fed cuts 25 it will be because they are afraid of what happens if they don’t as markets are already pricing in a 25 cut, even though this is what happened October 31, and Fisher said they wouldn’t price in a cut for that reason.

The Balance of Risks

So what would they anticipate if they don’t cut FF? The $ up, commodities down, stocks down, and credit spreads widening.

Is that risk less acceptable than the risk of promoting inflation and risking the elevation of inflation expectations if they do cut 25?

Then, there is the ‘compromise’ of cutting the discount rate and removing the stigma to address year end liquidity and ‘market functioning’ in general, with and/or without cutting the fed funds rate. The anticipated results would be a muted stock market reaction as FF/LIBOR spreads narrow, and hopefully, other credit spreads also narrow.

And if they cut the discount rate and don’t cut the FF rate, the $ will still be expected to go up and commodities down. And, with liquidity improved, stocks may be expected to do better as well.

But even though Kohn discussed this in his speech and others touched on the ‘liquidity versus the macro economy’ as well, there is no way to know how much consideration it may be given.

♥

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2007-12-07 US Economic Releases

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On 12/7/07, Karim Basta wrote:
>
>
> NFP +94k
> Net revisions -48k, with Sep revised from 96k to 44k (lowest mthly gain
> since 2/04)But October revised up to 170,000, indicating Sep the low so far, and
> improvement since then. And the Fed surely remember Sep 11 meeting
> where the Aug employment number was reported down and later revised to
> a relatively strong up number.

> UE rate down from 4.727% to 4.658%

And the Fed is concerned a falling labor force participation rate due to demographics means labor tightening with fewer new jobs.

> Most important to me was the diffusion index dropping below 50 (more
> industries losing jobs than gaining jobs) for the first time since Sep 2003

Yes, but only just below to 49.8 from 53.

> Retail job change from -15k to +24k looks suspect and reflective of poor
> seasonal adjustment factor;likely borrowing heavily from Dec job gwth
> Index of aggregate hours up 0.1% and avg hrly earnings up 0.5% (off a low
> 0.2% last mth)

Might result in Fed upward revisions for q4 gdp?

>
> Base case for next week is -25bps on FF and -50bps on DR.

2007-12-07 Change in Nonfarm Payrolls

Change in Nonfarm Payrolls (Nov)

Survey 80K
Actual 94K
Prior 166K
Revised 170K

Better than forecasting, and jobs being added about as fast as the fed thinks possible given fed perception of current demographics – no slack evident. Sept revised down and October up to 170,000 so the chart looks fine.

2007-12-07 Unemployment Rate

Unemployment Rate (Nov)

 

Survey 4.8%
Actual 4.7%
Prior 4.7%
Revised n/a

 

Better than forecast, and still well below the fed’s ‘unspoken’ concern that anything below 5% is more than non-inflationary full employment level.

2007-12-07 Change in Manufacturing Payrolls

Change in Manufacturing Payrolls (Nov)

 

Survey -15K
Actual -11K
Prior -21K
Revised -15K

 

2007-12-07 Average Hourly Earnings MoM

Average Hourly Earnings MoM

 

Survey 0.3%
Actual 0.5%
Prior 0.2%
Revised 0.1%

 

Above expectations, nudges up inflation risk.

2007-12-07 Average Hourly Earnings YoY

Average Hourly Earnings YoY

 

Survey 3.8%
Actual 3.8%
Prior 3.8%
Revised 3.6%

 

2007-12-07 Average Weekly Hours

Average Weekly Hours (Nov)

 

Survey 33.8
Actual 33.8
Prior 33.8
Revised n/a

 

Total hours holding up nicely and growing some – could see Q4 GPD numbers revised up by some firms.

2007-12-07 U. of Michigan Confidence

U. of Michigan Confidence (Dec P)

Survey 75.0
Actual 74.5
Prior 76.1
Revised n/a

 

This is also from watching CNBC.

2007-12-07 Comsumer Credit

Consumer Credit (Oct)

Survey $5.0
Actual $4.7B
Prior $3.7B
Revised $3.2B

 

Still in a reasonably narrow range.

♥

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Update: balance of risks since October 31st

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Conclusion

♥ Jury still out pending tomorrow’s employment number and pre meeting developments.

♥ Labor markets stronger than expected, inflation about as expected. While several funding spreads have widened vs fed funds, absolute rates for reasonable quality mtgs. and corp. bonds are down.

♥ The largest risk the Fed is probably worried about is that if they don’t match the 35 bp cut priced into the fed funds futures, the subsequent market reactions might result in extreme technical dysfunction. This was given as a non trivial factor for the 25 ‘insurance’ cut on October 31, and subsequent statements seemed determined to not have this be a factor at the next meeting. But it is.

Inflation

♥ CPI consensus (Dec 14): 4.1yoy from 3.5, core 2.3yoy from 2.2

♥ Oil down last from 94 at the meeting, vs 55 last year. Futures structure flattened.

♥ Prices received up in all the reported surveys (ism, purchasing mgrs, region feds, etc.), Phil Fed survey prices paid down slightly, others up.

♥ 10 year TIPS floater at 1.70 shows expectations of Fed only keeping a real rate of less than 2% for the next ten years.

♥ 10 year TIPS CPI break even rate down to 2.68 after month end when Nov fell out, from 2.77 at meeting. (interim high of 2.89)

♥ Michigan inflation expectations up – one year 3.4 from 3.1, 5 year 2.9 from 2.8.

♥ Q3 deflator up very slightly from .8 to .9.

♥ PCE deflator up 2.9 yoy, vs 1.8 pre Oct 31 meeting.

♥ Core PCE up .2, up 1.9 yoy. (unchanged)

♥ Q3 unit labor costs and productivity somewhat higher than expectations.

♥ OFHEO home price index down .4%, first decline since 1994, still up yoy, in line with forecasts.

♥ PPI up .1 vs up .3 expected, core flat vs up .2 expected, PPI 6.1% yoy, core 2.5%.

♥ Import prices up 1.8% vs 1.2 expected, yoy up 9.6% vs 9% expected.

♥ Saudi oil production up indicating higher demand at the higher prices.

Market Functioning/Financial Conditions

♥ Stocks down since the last meeting, but up for the year and substantially off the recent lows.

♥ Ff/libor wider but year end issue only.

♥ Mtg rates down, but jumbo mtg spreads vs fed funds and swaps widened.

♥ Bank loans up, commercial paper down.

♥ Assorted losses and recapitalizations but no business interruption.

♥ Mtg delinquencies up, probably within Fed forecasts.

Economic Outlook

♥ Mtg. apps strong and trending up.

♥ ADP employment strong.

♥ Weekly claims very slightly higher.

♥ GDP revised up to 4.9%.

♥ Personal income and spending up .2, (.1 less than private forecasts), real spending flat.

♥ Total vehicles sales unchanged.

♥ Factory orders up .5 and .3, above expectations.

♥ Consumer confidence down.

♥ Construction spending down .8, up .2, somewhat below expectations.

♥ Congressional response to adjustable rate mtgs.

♥ New home sales 728k vs 750k expected, then 716.

♥ Existing home sales 4.97m vs 5million.

♥ Permits 1.178m vs 1.200m expected prev revised to 1.261 from 1.226.

♥ Housing starts 1.229 vs 1.117 expected.

♥ NAHB housing index 19 vs 17 expected.

♥ Durable goods -.7 vs up .3 expected but previous month revised from .3 to up 1.1.

♥ Cap U 81.7 vs 82 expected.

♥ Industrial prod down .5 vs up .1 expected.

♥ Retail sales ex autos up .2 in line with expectations, core up .1%.

♥ Pending home sales up .2% vs down 2% expected.

♥ Sep trade balance -56.5 vs 58.5 expected.

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Re: more in ism

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(an interoffice email)

> ADP came in higher than expected and caused most dealers to raise their
> payroll forecasts.
>
> Productivity revised UP to 6.3% vs 4.9%preliminary. Unit Labor Costs revised
> to DOWN 2% vs. -0.2% preliminary.
> ISM Non-Manuf, Nov — slips to 54.1 vs. 55.8 prior, weaker-than-forecast.

still expanding

> Prices rose to 76.5 vs. 63.5,

inflation risks increasing

> Employment falls to 50.8 vs. 51.8,

still expanding

> New Orders
> slipped sharply to 51.1 vs. 55.7.

still expanding

> Bank of Canada cut rates this morning citing a soft outlook for US housing.

worried about their currency being too strong and losing demand to the US

> Fannie Mae cut it’s Quarterly dividend and announced it will be issuing
> preferred securities.

no business interruption

♥

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Re: BBC E-mail: UK interest rates trimmed to 5.5%

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(email)

Philip,

Yes, thanks. Might be to ‘give room’ to the Fed or maybe the modern version of ‘trade wars’ being played out?

The UK is saying to the US there’s a limit to using the $ as a ‘weapon’ to ‘steal’ agg demand. They see it as a game of chicken- the cb that’s willing to risk the inflation the most cuts and get the agg demand? An interesting twist on the ‘beggar they neighbor’ wars under fixed fx.

warren

On Dec 6, 2007 8:22 AM, Philip Arestis wrote:
> Philip Arestis saw this story on the BBC News website and thought you
> should see it.
>
> ** Message **
> Dear Warren,
>
> This has just come through. Not unexpected.
>
> Best wishes, Philip
>
> ** UK interest rates trimmed to 5.5% **
> The Bank of England cuts UK interest rates from 5.75% to 5.5% amid signs that the economy is slowing down.
> < http://news.bbc.co.uk/go/em/fr/-/1/hi/business/7130443.stm >

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Re: change of govt = change of practice

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(Email)

On Dec 5, 2007 11:50 PM, Wray, Randall wrote:
> Bill: thanks. Yes I think the data are overwhelming for very serious problems, for deep recession, and for rate cuts.
the problems to the real economy aren’t showing up yet

  1. exports have been more than filling the housing gap- as long as foreigners continue the move to ‘spend their hoard’ of $US we can probably muddle through for quite a while.
  2. housing feels like it’s bottomed and won’t be subtracting from gdp. mtg rates are lower than in august and banks are pushing hard to loan directly without the securitization process and are keeping the (wider) spreads for themselves.
  3. none of the losses so far have been anything more than rearranging financial assets and have not resulted in business interruption in the real economy.
  4. unlike the 30’s, we are not on the gold standard. If we had been on it, instead of the run up in gold prices of recent years the same relative value changes would have instead been evidenced by a massive deflation (gold held constant), outflows of gold from the govt, and maybe higher rates to keep that from happening, eventual devaluation (1934), and more powerful motivation for trade wars- all like the 1930’s and other standard gold standard collapses. So comps with the 1930’s can be highly misleading. With today’s non convertible currency the ‘adjustments’ are very different and the financial stresses tend to be more removed from main street. Note the s and l crisis, the crash of 87, the 98 credit crisis had relatively minor effects on gdp. Loans create deposits unconstrained by the gold supply, and capital is likewise both endogenous and not constrained by gold. Instead, all is constrained by income, and govts are pretty good at sustaining that at least at modest levels during slowdown with countercyclical tax structures leading the way, and lots of ‘off balance sheet deficit spending’ leaking out all over the world. This includes massive state bank lending from China, to even the eurozone (though that may be catching up with them under current arrangements), and budget deficits around the world sufficient for the moment to keep things muddling through.

> there is a very large body of evidence to indicate this is the worst situation seen in the US since the 1930s. It is a good time for >pragmatism and for throwing out silly rules. Central bankers are doing what they can. Unfortunately, as we all know only too well, the importance of fiscal policy is not understood.

Right, while I would cut rates to 0, I would also offset the resulting fiscal drag but cutting social security taxes. Irony is current rate cuts in isolation tighten the fiscal balance.
(http://www.epicoalition.org/docs/Forstater_Mosler_article.pdf)

Also, I’m thinking a world wide cap on the $ price of imported crude and domestic gasoline prices might be a short term path to price stability and a long term path to using less of it as costs of production rise and it can’t be sold profitable.

Just in the beginning stage of this concept!

Meanwhile, I don’t think any slowdown will cut net demand for crude sufficiently to take away Saudi and Russian pricing power for at least the next 6 months. and if they simply spend their income here the higher prices won’t slow gdp, just hurt our real terms of trade and keep upward pressure on cpi which is starting to spill over to core, and which the Fed won’t ignore as it climbs past 4, 5 and 6%.

warren

>There isn’t too much reason to be optimistic. As they say, we live in
interesting times, that are making us long for boring. See you in
January.
>
> L. Randall Wray
> Research Director
> Center for Full Employment and Price Stability
> 211 Haag Hall, Department of Economics
> 5120 Rockhill Road
> Kansas City, MO 64110-2499
> and
> Senior Scholar
> Levy Economics Institute
> Blithewood
> Bard College
> Annandale-on-Hudson, NY 12504
>
> ________________________________
>
> From: Warren Mosler [mailto:warren.mosler@gmail.com]
> Sent: Wed 12/5/2007 8:13 PM
> To: Bill Mitchell
> Subject: Re: change of govt = change of practice
>
>
>
>
> Hi Bill, good info, thanks very much!
>
> warren
>
> On Dec 5, 2007 3:48 PM, Bill Mitchell wrote:
> > dear warren
> >
> > history was made yesterday – the RBA published the minutes of their
> > meeting
> > on Tuesday where they spell out their reasoning on rates (no change).
> > This
> > is the first time they have done that and it follows the election
> > campaign where
> > Rudd made a big point of returning honesty and transparency to his govt
> > after
> > the bad howard years of lying and covering up anything that moved.
> >
> > So you can see the minutes tell you that a further rate rise is now not
> > inevitable
> > despite inflation being above the magic upper bound of 3 and despite
> > them expecting
> > it to remain that way for at least 6 months more.
> >
> > They are now saying that world trends are for lower interest rates to
> > cope with the
> > worsening credit crisis.
> >
> > So: (a) their strict Inflation Targetting is being violated by “other
> > concerns”
> > (b) they think the US is heading for recession.
> >
> > local commentators last night said the Fed will lower by 0.5 next week
> > after BOC went
> > down this week and BOE is heading that way too.
> >
> > anyway, today the CofFEE conference starts – 2 days.
> >
> > see you
> > bill

♥

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BoC cuts rates

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Makes a lot more sense to Central Bankers to cut with a strong currency than a weak one, particularly with the strong currency keeping prices below their inflation targets.

The ECB, however, is looking at 3% cpi, and would rather not see the Fed cut, as they believe that would weaken the $ and bring more criticism from their eurozone exporters, as well as draw more agg demand away from the eurozone, making it that much more difficult politically for the ECB to act within its price stability mandate.

OTTAWA – The Bank of Canada today announced that it is lowering its target for the overnight rate by one-quarter of one percentage point to 4 1/4 per cent. The operating band for the overnight rate is correspondingly lowered, and the Bank Rate is now 4 1/2 per cent.Since the October Monetary Policy Report (MPR), there have been a number of economic and financial developments that have a bearing on the prospects for output and inflation in Canada.Consistent with the outlook in the MPR, the global economic expansion has remained robust and commodity prices have continued to be strong. The Canadian economy has been growing broadly in line with the Bank’s expectations, reflecting in large part underlying strength in domestic demand. However, both total CPI inflation and core inflation in October, at 2.4 per cent and 1.8 per cent respectively, were below the Bank’s expectations, reflecting increased competitive pressures related to the level of the Canadian dollar. The Bank now expects inflation over the next several months to be lower than was projected in the MPR. In the context of exceptional volatility in global financial markets, the Canadian dollar spiked well above parity with the U.S. dollar in November, but it has recently traded closer to the 98-cent-U.S. level assumed in the October MPR.Overall, the Canadian economy continues to operate above its production capacity. Given the strength of domestic demand and weak productivity growth, there continue to be upside risks to the Bank’s inflation projection.However, other developments since October suggest that the downside risks to the Bank’s inflation projection have increased. Global financial market difficulties related to the valuation of structured products and anticipated losses on U.S. sub-prime mortgages have worsened since mid-October, and are expected to persist for a longer period of time. In these circumstances, bank funding costs have increased globally and in Canada, and credit conditions have tightened further. There is an increased risk to the prospects for demand for Canadian exports as the outlook for the U.S. economy, and in particular the U.S. housing sector, has weakened.All these factors considered, the Bank judges that there has been a shift to the downside in the balance of risks around its October projection for inflation through 2009. In light of this shift, the Bank has decided to lower the target for the overnight rate. At its next interest rate decision in January, the Bank will assess all economic and financial developments and the balance of risks. A full projection for the economy and inflation will be published in the Monetary Policy Report Update on 24 January 2008.

♥

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Review of Yellen Speech

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(from an interoffice email)

Karim:
Quite a long one http://www.frbsf.org/news/speeches/2007/1203.html, but here goes, with selected excerpts, headings my own.

If you don’t want to read the rest, one word describes it, DOVISH…if she was voting next week, she’d vote for 50bps.

Warren:
Agreed. Though the heightened inflation risks at the end do add some balance. This is far different from the Bernanke and Kohn speeches, and seems this is what they would have said if they held the same opinion.

Conditions are worse from 10/31/07
When the shock first hit, I expected the reverberations to subside gradually, especially in view of the easing in the stance of policy, so that by now there would have been a noticeable improvement in financial conditions. Indeed, though the reverberations have ebbed at times over the last four and a half months, since the October meeting market conditions have deteriorated again, and indications of heightened risk-aversion continue to abound both here and abroad.Mortgages in particularAlthough borrowing rates for low-risk conforming mortgages have decreased, other mortgage rates have risen, even for some borrowers with high credit ratings. In particular, fixed rates on jumbo mortgages are up on net since mid-July. Subprime mortgages remain difficult to get at any rate.Moreover, many markets for securitized assets, especially private-label mortgage-backed securities, continue to experience outright illiquidity; in other words, the markets are not functioning efficiently, or may not be functioning much at all. This illiquidity remains an enormous problem not only for companies that specialize in originating mortgages and then bundling them to sell as securities, but also for financial institutions holding such securities and for sponsors, including banks, of structured investment vehicles—these are entities that relied heavily on asset-backed commercial paper to fund portfolios of securitized assets.

To assess how financial conditions relevant to aggregate demand have changed since the shock first hit, we must consider not only credit markets but also the markets for equity and foreign exchange. These markets have hardly been immune to recent financial turbulence. Broad equity indices have been very volatile, and, on the whole, they have declined noticeably since mid-July, representing a restraint on spending.

Econ Outlook weaker than expected for longer; She’s not mincing words in this section

The fourth quarter is sizing up to show only very meager growth. The current weakness probably reflects some payback for the strength earlier this year—in other words, just some quarter-to-quarter volatility due to business inventories and exports. But it may also reflect some impact of the financial turmoil on economic activity. If so, a more prolonged period of sluggishness in demand seems more likely.

First, the on-going strains in mortgage finance markets seem to have intensified an already steep downturn in housing.

This weakness in house construction and prices is one of the factors that has led me to include a “rough patch” in my forecast for some time. More recently, however, the prospects for housing have actually worsened somewhat, as financial strains have intensified and housing demand appears to have fallen further.

Moreover, we face a risk that the problems in the housing market could spill over to personal consumption expenditures in a bigger way than has thus far been evident in the data. This is a significant risk since personal consumption accounts for about 70 percent of real GDP. These spillovers could occur through several channels. For example, with house prices falling, homeowners’ total wealth declines, and that could lead to a pullback in spending. At the same time, the fall in house prices may constrain consumer spending by changing the value of mortgage equity; less equity, for example, reduces the quantity of funds available for credit-constrained consumers to borrow through home equity loans or to withdraw through refinancing. Furthermore, in the new environment of higher rates and tighter terms on mortgages, we may see other negative impacts on consumer spending. The reduced availability of high loan-to-value ratio and piggyback loans may drive some would-be homeowners to pull back on consumption in order to save for a sizable down payment. In addition, credit-constrained consumers with adjustable-rate mortgages seem likely to curtail spending, as interest rates reset at higher levels and they find themselves with less disposable income.

Moreover, there are significant downside risks to this projection. Recent data on personal consumption expenditures and retail sales are not that encouraging. They have begun to show a significant deceleration—more than was expected—and consumer confidence has plummeted. Reinforcing these concerns, I have begun to hear a pattern of negative comments and stories from my business contacts, including members of our Head Office and Branch Boards of Directors. It is far too early to tell if we are in for a sustained period of sluggish growth in consumption spending, but recent developments do raise this possibility as a serious risk to the forecast.

Net Exports to weaken along with decoupling

I anticipate ongoing strength in net exports, but perhaps somewhat less than in recent years, since foreign activity may be somewhat weaker going forward. Some countries are experiencing direct negative impacts from the ongoing turmoil in financial markets. Others are likely to suffer indirect impacts from any slowdown in the U.S. For example, most Asian economies are now enjoying exceptionally buoyant conditions. But the U.S. and Asian economies are not decoupled, and a slowdown here is likely to produce ripple effects lowering growth there through trade linkages.

Now for the bright side-

I don’t want to give the impression that all of the available recent data have been weak or overemphasize the downside risks. There are some significant areas of strength. In particular, labor markets have been fairly robust in recent months. As I mentioned before, the growth of jobs is an important element in generating the expansion of personal income needed to support consumption spending, which is a key factor for the overall health of the economy. In addition, business investment in equipment and software also has been fairly strong, although here too, recent data suggest some deceleration. Despite the hike in borrowing costs for higher-risk corporate borrowers and the illiquidity in markets for collateralized loan obligations, it appears that financing for capital spending for most firms remains readily available on terms that have been little affected by the recent financial turmoil.

If we cut aggressively, we might grow at trend

To sum up the story on the outlook for real GDP growth, my own view is that, under appropriate monetary policy, the economy is still likely to achieve a relatively smooth adjustment path, with real GDP growth gradually returning to its roughly 2½ percent trend over the next year or so, and the unemployment rate rising only very gradually to just above its 4¾ percent sustainable level. However, for the next few quarters, there are signs that growth may come in somewhat lower than I had previously thought likely. For example, some of the risks that I worried about in my earlier forecast have materialized—the turmoil in financial markets has not subsided as much as I had hoped, and some data on personal consumption have come in weaker than expected. I continue to see the growth risks as skewed to the downside in part because increased perceptions of downside economic risk may induce greater caution by lenders, households, and firms.

Core PCE likely to slow further but still some upside risks

Turning to inflation, signs of improvement in underlying inflationary pressures are evident in recent data. Over the past twelve months, the price index for the measure of consumer inflation on which the FOMC bases its forecasts—personal consumption expenditures excluding food and energy, or the core PCE price index—has increased by 1.9 percent. Just several months ago, the twelve-month change was quite a bit higher, at nearly 2½ percent.

It seems most likely that core PCE price inflation will edge down to around 1¾ percent over the next few years under appropriate policy and the gap between total and core PCE inflation will diminish substantially. Such an outcome is broadly consistent with my interpretation of the Fed’s price stability mandate. This view is predicated on continued well-anchored inflation expectations. It also assumes the emergence of a slight amount of slack in the labor market, as well as the ebbing of the upward effects of movements in energy and commodity prices. However, we do still face some inflation risks, mainly due to faster increases in unit labor costs, the depreciation of the dollar, and the continuing upside surprises in energy prices. Moreover, labor markets have continued to surprise on the strong side. All of these factors will need to be watched carefully going forward.

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Feds’ budget tricks hide trillions in debt

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Feds’ Budget Tricks Hide Trillions in Debt

-Scott Burns
Every year, tens or even hundreds of billions of dollars are quietly added to the national debt — on top of the deficits that we hear about. What’s going on here?

Burns doesn’t get it.

When it comes to financial magic, the government of the United States takes the prize. Sleights of hand and clever distractions by purveyors of line-of-credit mortgages, living-benefit variable annuities and equity-indexed life insurance are clumsy parlor tricks compared with the Big Magic of American politicians.Consider the proud trumpeting that came from Washington at the close of fiscal 2007. The deficit for the unified budget was, politicians crowed, down to a mere $162.8 billion.

In fact, our government is overspending at a far greater rate. The total federal debt actually increased by $497.1 billion over the same period.

But politicians of both parties use happy numbers to distract us. Democrats routinely criticize the Republican administration for crippling deficits, but they politely use the least-damaging figure, the $162.8 billion. Why? Because references to more-realistic accounting would reveal vastly greater numbers and implicate both parties.

No, because they are right and Burns is wrong.

You can understand how this is done by taking a close look at a single statement on federal finance from the president’s Council of Economic Advisers. The September statement shows that the “on-budget” numbers produced a deficit of $344.3 billion in fiscal 2007. The “off-budget”> numbers had a surplus of $181.5 billion. (The off-budget figures are dominated by Social Security, Medicare and other programs with trust funds.)

Correct. Net government spending in the non government sectors is what ‘counts’. Intergovernment transfers of anything are of no economic consequence to the rest of us. They have no current year impact on aggregate demand.

Combine those two figures and you get the unified budget, that $162.8 billion. In the past eight years we’ve had two years of reported surpluses and six years of reported deficits. Altogether, the total reported deficit has run $1.3 trillion.But if you examine another figure, the gross federal debt, you’ll see something strange. First, the debt has increased in each of the past eight years, even in the two years when surpluses were reported. Second, the gross federal debt, which includes the obligations held by the Social Security and Medicare trust funds, has increased much faster than the deficits — about $3.3 trillion over the same eight years.

They are correct, as above, by not including transfers of securities from one government agency to another.

That’s $2 trillion more than the reported $1.3 trillion in deficits over the period. Can you spell “Enron”?

Pass on the comebacks and go on to the text.

In other words, while our reported deficits averaged $164 billion over the past eight years, government debt increased an average of $418 billion a year. That’s a lot more than twice as much. How could this happen?

How can a responsible new sight publish this nonsense???

Easy. The Treasury Department simply credits the Social Security, Medicare and other trust funds with interest payments in the form of new Treasury obligations. No cash is actually paid.

Why should it be???

The trust funds magically increase in value with a bookkeeping entry.

That’s all the $ is in any case – a bookkeeping entry. Get over it!

It represents money the government owes itself.

Right, which has no current year effect on the real economy. It changes buys or sells of real goods and services.

So what happens if we take out the funny money?

What does ‘take out’ mean? Simply transferring from one account at the the fed to another. More entries. Can’t be anything more. That’s all the $ is.

When the imaginary interest payments are included, Social Security and Medicare are running at a tranquilizing surplus (that $181.5 billion mentioned earlier). But measure actual cash, and the surplus disappears.

What is ‘actual cash’???

In 2005, for instance, the Social Security Disability Income program started to run at a cash loss. 2007 is the first year that Medicare Part A (the hospital insurance program) benefits exceeded income.

The same thing will happen to the Social Security retirement-income program in six to nine years, depending on which of the trustees’ estimates you use. During the same period, the expenses of Medicare Part B and Part D, which are paid out of general tax revenue, will rise rapidly.

Point???

Despite this, the Social Security Administration writes workers every year advising them that the program will have a problem 34 years from now, not six or nine years. In fact, the real problem is already here. It will be a big-time problem in less than a decade.

Define ‘big time’. Government going to bounce checks? If the government runs deficits in the out year that are ‘too large’ the evidence will be inflation, not solvency. If he thinks there’s a potential inflation issue, fine, but he doesn’t or he would have said it.

Count on it.

Count on more of this nonsense.

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Review of Bernanke Speech

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(prefaced by interoffice email)

> Key line is the Committee will have to judge whether the outlook
> for the economy or the balance of risks has shifted materially. This
> opens the door for changing the balance of risk at the next FOMC
> meeting (Towards weaker gwth in light of expressed concerns on
> markets). This could mean a cut with a changed bias, or no cut
> and a changed bias (less likely).

Yes, agreed, and the inflation risk has elevated as well.

If they are thinking of a discount rate cut to the fed funds rate they may do it before the meeting to see if it alters the fed funds/libor spread. If they do that and spreads do come in over year end (the current cause of higher short term non tsy rates as mentioned in some of the Fed speeches) that will tilt the balance of risks aways from ‘market functioning’ risks.

Worth looking at the entire speech..

Chairman Ben S. Bernanke
National and regional economic overview
At the presentation of the Citizen of the Carolinas Award, Charlotte
Chamber of Commerce, Charlotte, North Carolina
November 29, 2007

Good evening. I thank the Charlotte Chamber of Commerce for bestowing on me this year’s Citizen of the Carolinas Award. I deeply appreciate the honor, and I am grateful for the opportunity it gives me to speak to you this evening. I am also delighted to be here in Charlotte. My wife Anna and I are looking forward to visiting family and friends during our time here in the Queen City.

The focus of my brief remarks this evening will be the Charlotte region and how the area and the economy have changed since I regularly visited my grandparents here some four-and-a-half decades ago. First, though, I would like to share a few thoughts on the U.S. economy and the considerations that we at the Federal Reserve will be weighing as we prepare for our policy meeting on December 11, less than two weeks from now.

The Federal Open Market Committee (FOMC), the monetary policy making arm of the Federal Reserve System, last met on October 30-31. At that meeting, the Committee cut its target for the federal funds rate, the key policy interest rate, by 25 basis points (1/4 of a percentage point), following a cut of 50 basis points in September. Economic growth in the period leading up to the October meeting had proven quite strong, as confirmed by this morning’s figures on third-quarter gross domestic product (GDP). At its meeting, however, Committee members took the view that tightening credit conditions–the product of ongoing stresses in financial markets–and some intensification of the correction in the housing sector were likely to restrain economic activity going forward.

Potential ‘market functioning’ risk.

Specifically, growth appeared likely to slow significantly in the fourth quarter from its rapid third-quarter rate and to remain sluggish in early 2008. The Committee expected that economic growth would thereafter gradually return to a pace approaching its long-run trend as the drag from housing subsided and financial conditions improved. Inflation was seen as edging down next year, approaching rates consistent with price stability;

Implying it’s too high now.

however, the Committee remained concerned about the possible effects of higher energy costs and the lower foreign exchange value of the dollar, especially the risk that they might lead to an increase in the public’s long-term inflation expectations.

Yes, which led to a dissenting vote and six regional banks not wanting a cut.

How has the economic picture changed in the month since that meeting? As is often the case, the incoming economic data have been mixed.

This is the sum of data – not clearly worse and not clearly worse than forecast. My guess in Q4 is their Q4 forecast has been revised up, and the continual upward revisions of Q3 and now Q4 have to be influencing their view of Q1 forecasts and beyond as well.

In the market for residential real estate, indicators of construction and home sales have continued to be weak. In contrast, the labor market remained solid in October, with some 130,000 new jobs added to private-sector payrolls and the unemployment rate remaining at 4.7 percent. Claims for unemployment insurance have drifted up a bit in recent weeks, although, on average, they have remained at a level consistent with moderate expansion in employment. We will, of course, have the labor market report for November next week, and in the coming days we will continue to draw on anecdotal reports, surveys, and other sources of information about employment and wages. Continued good performance by the labor market is important for maintaining the economic expansion, as growth in earnings helps to underpin household spending.

Strong emphasis on employment data. It has probably been the most reliable indicator over the last six months. No one could ‘understand’ how employment remained high until after late numbers on exports came in, for example.

With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

And ‘on the soft side’ is no reason to cut – especially with exports growing rapidly and supporting demand at high levels.

Core inflation–that is, inflation excluding the relatively more volatile prices of food and energy–has remained moderate.

But not moderated further.

However, the price of crude oil has continued its rise over the past month, a rise that will be reflected in gasoline and heating oil prices and, of course, in the overall inflation rate in the near term. Moreover, increases in food prices and in the prices of some imported goods have the potential to put additional pressures on inflation and inflation expectations.

He is stating directly the inflation risk has increased since October 31.

The effectiveness of monetary policy depends critically on maintaining the public’s confidence that inflation will be well controlled. We are accordingly monitoring inflation developments closely.

They believe they must have credibility to keep inflation expectations anchored.

The incoming data on economic activity and prices

Both – which includes CPI forecasts available before the December 11 meeting.

will help to shape the Committee’s outlook for the economy; however, the outlook has also been importantly affected over the past month by renewed turbulence in financial markets, which has partially reversed the improvement that occurred in September and October.

Partially. Being in the middle with active trading is perfectly acceptable. The concern is spreads will widen further/rapidly to the point trading ceases and real world lending ceases as a consequence, though the ‘channel’ for this is uncertain, and mainstream economic theory probably would say it’s a natural adjustment process that should be left alone for optimal long term outcomes.

Comments welcome on this point, thanks!

Investors have focused on continued credit losses and write-downs across a number of financial institutions, prompted in many cases by credit-rating agencies’ downgrades of securities backed by residential mortgages. The fresh wave of investor concern has contributed in recent weeks to a decline in equity values, a widening of risk spreads for many credit products (not only those related to housing), and increased short-term funding pressures.

All a repricing of risk.

These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors.

But perhaps to where it ‘should be’ as the fed did not like it when risk was priced at zero. What they are watching closely is ‘market functioning’ and the risk of systemic failure.

Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy.

As above.

In sum, as I have indicated, we will be receiving a good deal of relevant information in the coming days. In making its policy decision, the Committee will have to judge whether the outlook for the economy or the balance of risks has shifted materially.

Implying so far it has not.

In doing so, we will take full account of the implications for the outlook of both the incoming economic data and the ongoing developments in the financial markets.Economic forecasting is always difficult, but the current stresses in financial markets make the uncertainty surrounding the outlook even greater than usual. We at the Federal Reserve will have to remain exceptionally alert and flexible as we continue to assess how best to promote sustainable economic growth and price stability in the United States.

Perhaps a reference to Kohn’s discount rate discussion where he discusses addressing liquidity vs. addressing the macro economy, a discussion which has gotten into the ‘stigma’ aspect of the discount rate that he felt was an obstacle to liquidity.

References
Employment Security Commission of North Carolina (2007). “Employment
and Wages by Industry, 1990 to Most Recent,”
www.ncesc.com/lmi/industry/industrymain.asp.

Hills, Thomas D. (2007). “The Rise of Southern Banking and the
Disparities among the States following the Southeastern Regional
Banking Compact (225 KB PDF),” Balance Sheet, vol. 11, pp. 57-104,
http://studentorgs.law.unc.edu/ncbank/balancesheet.

North Carolina Community College System (2006). “Get the Facts,”
press release, July 3,
www.ncccs.cc.nc.us/News_Releases/GetTheFacts.htm.

U.S. Census Bureau (2006). “2005 American Community Survey,”
www.census.gov/acs.

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