Fed communications

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If conveying information is considered important for market function, why not just say it clearly and directly in a targeted announcement?

Kohn Says Fed Is Trying to Signal When Views Shift `Materially’

2008-01-05 11:15 (New York)
By Scott Lanman and Steve Matthews

(Bloomberg) Federal Reserve Vice Chairman Donald Kohn said the central bank has increased its communication on policy views to the public in the wake of the financial-market “turmoil” that began in August.

Fed officials have tried to signal when the central bank’s reading on the economic outlook shifted “materially” in between regular meetings, Kohn said in a speech in New Orleans. “We have tried to provide more information than usual to reduce uncertainty and clarify our intentions.”

Kohn spoke before a week in which Chairman Ben S. Bernanke and six other Fed policy makers are scheduled to deliver remarks. The speeches come amid increasing signs of danger to the U.S. economic expansion, including a jump in the unemployment rate to a two-year high and a contraction in manufacturing. Traders anticipate the Fed will cut interest rates again Jan. 30.

Still, investors “should understand” that officials “do not coordinate schedules and messages, and that members’ views are likely to be especially diverse” when circumstances are rapidly changing, Kohn said.

Kohn held out Bernanke’s last speech on Nov. 29 as a signal of a change in the Fed’s views. The chairman said at the time that volatility in credit markets had “importantly affected” the economic outlook and declined to repeat the Federal Open Market Committee’s October statement that inflation and growth risks were about equal. The Fed then cut rates on Dec. 11.

`Let People Know’

“We have attempted to let people know when our views of the macroeconomic situation had changed materially between FOMC meetings,” said Kohn said in prepared remarks at the National Association for Business Economics panel discussion, part of the Allied Social Science Associations annual meeting.

The vice chairman didn’t comment on the outlook for monetary policy or the economy in the text of his remarks.

Bank of Japan Deputy Governor Kazumasa Iwata and European Central Bank Vice President Lucas Papademos were also scheduled to speak in the same session.

Traders yesterday shifted to bets on 50 basis points of interest-rate cuts by the Fed this month from 25 basis points after U.S. hiring slowed more than forecast in December and unemployment rose to 5 percent. The Fed lowered its main rate a quarter percentage point to 4.25 percent at its last meeting on Dec. 11. A basis point is 0.01 percentage point.

Fed Speakers

Bernanke speaks Jan. 10 in Washington. Other Fed officials giving talks include Boston Fed President Eric Rosengren and Kansas City Fed President Thomas Hoenig, the last two policy makers to cast dissenting FOMC votes. Charles Plosser, head of the Philadelphia Fed, votes as an FOMC member for the first time this month; he will discuss his economic outlook Jan. 8.

The FOMC is scheduled to meet Jan. 29-30 in Washington.

Separately, Kohn said today that the FOMC’s new forecasts for inflation three years out do not represent an “explicit numerical definition of price stability,” something the committee decided against, but rather the inflation rate that is “acceptable and consistent with fulfilling our congressional mandates.”

Kohn, who said in 2003 that he was “skeptical” about a price target, chaired a subcommittee of officials that coordinated work on the Fed’s communication review that began in 2006. He suggested in September that his doubts about the idea had eased.

Inflation Expectations

“I expect that our new projections will provide some of the benefits of an explicit target in better anchoring inflation expectations while not giving up any flexibility to react to developments that threaten high employment,” Kohn said today.

He also echoed remarks by Bernanke that the Fed will continue to look for “additional steps” to improve communication.

Fed officials decided last year not to report members’ assumptions of the “appropriate” path of interest rates because of concern that investors would “infer more of a commitment to following the implied path than would be appropriate for good policy,” the vice chairman said.

Kohn, speaking yesterday at the same conference, said diverse views on the 19-member FOMC lead to better monetary policy decisions. “The authority of the chairman rests on his ability to persuade the other members of the committee that the choices they are making under his leadership will accomplish their objectives,” he said.

–Editor: Chris Anstey, Christopher Wellisz
To contact the reporter on this story:
Scott Lanman in Washington at +1-202-624-1934 or
slanman@bloomberg.net;
Steve Matthews in New Orleans at +1-404-507-1310 or
smatthews@bloomberg.net.

To contact the editor responsible for this story:
Chris Anstey at +1-202-624-1972 or canstey@bloomberg.net

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Re: banking system proposal

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Dear Philip,

Yes, as in my previous posts, bank stability is all about credible deposit insurance.

I would go further, and have all regulated, member banks, be able to fund via an open line to the BOE at the BOE target rate.

That would eliminate the interbank market entirely, and let all those smart people doing those jobs go out and do something useful, maybe cure cancer, for example!

This would not change the quantity of retail bank deposits, only the rate paid on those deposits, which would be something less than the BOE target rate. Loans create deposits so they are all still there, but with this proposal all the banks would necessarily bid a tad less than the BOE target rate for deposits. And note this pretty much the case anyway.

With insured deposits market discipline comes from via capital requirements, and regulators also tend to further protect their
insured deposits by creating a list of ‘legal assets’ for banks, as well as various other risk parameters. The trick is to make sure the shareholders take the risk and not the govt.

This would change nothing of macro consequence but it would enhance the efficiency and stability of the banking sector, presumably for further public purpose.

Note to that the eurozone has the same issue, only perhaps more so, as the ECB is prohibited by treaty from ‘bailing out’ failed banks. Hopefully this gets addressed before it is tested!

All the best,

Warren

On Jan 5, 2008 7:46 PM, <noreply@sundayherald.com> wrote:
>
>
> Hi Warren Moslder,
>
> Philip Arestis stopped by Sunday Herald
> website and suggested that you visit the following URL:
>
> http://www.sundayherald.com/business/businessnews/display.var.1945229.0.outbreak_of_common_sense_could_save_british_banking.php
>
> Here is their message …
>
> Dear Warren,
>
>
>
> Interesting developments over here. Would it make much difference I wonder.
>
>
>
> Best wishes, Philip
>
>

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Re: fed mandate discussion

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On 03 Jan 2008 20:05:33 +0000, Prof. P. Arestis wrote:
> Dear Warren,
>
(snip)
>
> One point is this: some more extreme people would argue that low inflation
> is both a necessary and sufficient condition for optimal longterm growth and
> employment.

Dear Philip,

Agreed, and we will soon see if the Fed leans in that direction, as
they professed repeatedly before Sept of this year as the way they
complied with their dual mandate of price stability and full
employment.

Seems hard to imagine a change to something like “full employment is a
necessary condition for low and stable prices” but I suppose anything
is possible!

All the best,

Warren

>
> Best wishes,
>
> Philip

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Re: fiscal response

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On 04 Jan 2008 22:29:03 +0000, Prof. P. Arestis wrote:
> Dear Warren,
>
> Many thanks.
>
> This is all interesting. The sentence that caught my eye is this: “A fiscal

> package is being discussed to day by Bernanke, Paulson, and Bush. That

> would also reduce the odds of a Fed cut”. This would indeed reduce the odds
> of a rate cut. But would Bernanke accept such a proposition when he
> believes passionately that crowding-out in fiscl policy is very much the
> order of the fiscal day? I am curious to see the result of this discussion.

Dear Philip,

Very good point!

Warren

>
> Best wishes,
>
> Philip
>

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2008-01-04 US Economic Releases

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2008-01-04 Unemployment Rate

Unemployment Rate (Dec)

Survey 4.8%
Actual 5.0%
Prior 4.7%
Revised n/a

It comes from the household survey – been volatile.

2008-01-04 Change in Nonfarm Payrolls

Change in Nonfarm Payrolls (Dec)

Survey 70K
Actual 18K
Prior 94K
Revised 115K

2008-01-04 Change in Manufacturing Payrolls

Change in Manufacturing Payrolls (Dec)

Survey -15K
Actual -31K
Prior -11K
Revised -13K

Payroll increases continue to decline modestly over time. The fed believes demographic changes will reduce the labor force participation rate, keeping unemployment relatively low and labor markets tight, even with fewer jobs.

2008-01-04 Average Hourly Earnings MoM

Average Hourly Earnings MoM

Survey 0.3%
Actual 0.4%
Prior 0.5%
Revised 0.4%

2008-01-04 Average Hourly Earnings YoY

Average Hourly Earnings YoY (Dec)

Survey 3.6%
Actual 3.7%
Prior 3.8%
Revised n/a

Remains firm, and productivity probably down, meaning unit labor costs rising some.

2008-01-04 Average Weekly Hours

Average Weekly Hours (Dec)

Survey 33.8
Actual 33.8
Prior 33.8
Revised n/a

2008-01-04 ISM Non-Manufacturing

ISM Non-Manufacturing (Dec)

Survey 53.6
Actual 53.9
Prior 54.1
Revised

Very firm and cross checks with th 93,000 increase in service sector jobs for December.

ISM Non-Manufacturing TABLE ISM Non-Manufacturing TABLE

ISM Non-Manufacturing TABLE

Note the strength in the price categories.

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Re: US Libor GC Spreads comment

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(an interoffice email)

Good report, thanks!

On Jan 4, 2008 10:41 AM, Pat Doyle wrote:
>
>
>
> Pre- August 2007 GC US Treasury’s repo averaged Libor less 17 across the
> curve. In early August and again in early December the spread between GC
> and Libor hit it’s wides in excess of 150bps for 3m repo and 180bps for
> 1mos.
>
>
>
> Today’s Spreads:
>
> 1m = L -46.5
>
> 3m = L – 77
>
> 6m = L – 82
>
>
>
> This recent narrowing of the spread is primarily a result of the TAF
> program and CB intervention but may also be attributed to continuing
> writedowns of assets. There is plenty of cash in the short term markets and
> now some of this cash is going out the curve helping to narrow Libor
> spreads. The problem banks continue to have is that their balance sheet size
> and composition is adversely affecting their capital ratios. Banks and
> Dealers remain very cautious about adding risk assets to their balance
> sheets. Bids are defensive as dealers are demanding higher rents (return
> for risk) for balance sheet. Dislocations still exist, for example it may
> make no sense from a credit perspective but AAA CMBS on open repo trades at
> FF’s + 75, while IG Corp trades FF’s + 40, even NON IG Corps trade tighter
> than AAA CMBS. The more assets are either sold or otherwise liquidated off
> of the balance sheets and the more transparent the balance sheet
> compositions become, then the quicker the markets will stabilize
>
>
>
> GRAPH OF 1 MONTH LIBOR VS. 1 MONTH UST GC
>
>

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Payrolls

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(email)

On Jan 4, 2008 10:43 AM, Mike wrote:

> Warren, right now economic sectors in stock mkt are pricing in a severe
> recession-your call on no recession is extremely out of consensus now-I
> think that mkt has overdone the recession theme short term…

Agreed!

We may get to 0 or negative growth for a quarter or so, but probably not due to financial sector losses, ‘market functioning’ issues, or housing related issues.

More likely if it happens it will be a fall off in exports or something like that.

Also, the Fed can’t talk about it, but it knows it’s way behind the inflation curve due to fears of ‘market functioning.’ Their concern now turns to the ‘insurance premium’ they paid- food, fuel, $/import prices.

ISM service just came out- solid number.

Orders and employment strong, prices strong.

And in today’s employment number service sector jobs expanded faster than the rest fell, so q4 remains ok at 2% or so, and q1 still looks up.

I still see GDP muddling through (assuming exports hold up), and upward price pressures continuing indefinately as Saudis/Russians keep hiking.

Saudi production numbers due out for Dec any day. That’s the best indicator we have for whether demand is holding up at current prices.

warren
> Mike

Yes, a weak number for sure, though probably as expected by those originally looking for negative growth for the entire quarter.

And only a few months ago a negative employment number was revised to a strong up number.

And unemployment is also a lagging indicator, reflecting the weakness of several months ago.

Service sector added 93,000, other sectors lost, so employment continues its multi year shift.

And, however weak demand may have been, from the Fed’s point of view it was still strong enough to further drive up food/fuel/import prices.

3 mo libor down again and now about 75 bps lower than August in absolute terms, and spread to ff falling and way down from the wides, cp starting to expand, and most everything indicating market functioning returning and financial conditions easing..

The Fed views this as an ‘ease’ the same way it viewed the reverse as a ‘tightening’ when it cut 50.

Even write down announcements have subsided with less than 100 billion in write offs announced so far. In 1998, for example, $100 billion was lost the first day due to the Russian default, with no prospect of recoveries. That’s probably equiv to a 300b initial loss today.

Also heard this statement on CNBC: current oil prices mean $4 gasoline at the pump, and that will cut into consumer spending so the Fed has to cut rates to keep us out of recession.

That’s exactly what the Fed doesn’t want to happen- they call that monetizing a negative supply shock and turning a relative value story into an inflation story.

With the return of ‘market functioning’ the risks to growth change dramatically for the Fed.

They are now far less concerned about ‘the financial system shutting down’ and instead can now get back to their more familiar discussion of the long term relation between inflation and growth when making their decisions.

A fiscal package is being discussed to day by Bernanke, Paulson, and Bush. That would also reduce the odds of a Fed cut.

With their belief that fiscal is for the economy and monetary policy for inflation, the mainstream might prefer to see a fiscal response to support gdp rather than an inflation inducing rate cut to support growth.

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A blurb from a broker

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(email)

>
> An impressive November Factory Orders report offered a respite from the
> recent round of weak economic data.

Yes, and maybe even nudge up Q4 forecasts (forecasting the past).

Also, if you look at the continuing claims graph since 1980, it is very low, especially when considering the growth in the labor force, and the latest rise isn’t yet at all meaningful.

> Another data point likely be viewed as
> an incremental positive by the Fed, was the first increase in Asset-Backed
> Commercial Paper outstanding in 20 weeks.

Yes, and the banks are now actively competing for that business. Markets are ‘functioning’ albeit at different rates than before.

> The ABCP market has been around
> for over 20 years. Between 2005 to 2007 it grew by 80% to $1.2 trillion as
> it became the primary funding tool for SIVs.

Yes. And before that, GDP managed to somehow grow, hitting 6%+ in the late 90s before the surplus took it all down.

There is now very good evidence -not that it was needed- that the financial sector adds little or nothing of value to the ‘real economy’ and instead acts as a massive ‘brain drain’ on the real economy.

> The market enabled SIVs to
> initiate hundreds of billions of dollars of leveraged spread trades. The
> SIVs borrowed short in the ABCP market and used the cash to finance
> purchases of mortgage backed securities, CDO’s and other credit instruments.
> Investors have made it clear to the ABCP market that they will no longer
> finance these carry trades. As a result, from August to December. The ABCP
> market shrunk by 37%. One of the concerns, the Fed has expressed has been
> that the legitimate participants in the ABCP market would be cut off from
> financing.

Right, hasn’t happened, and now, as you state, it is going the other way, and cheaper wholesale funding is again becoming available and again taking that lending away from the banks..

> This news could be the first to sign the ABCP market is
> returning to a sense of normalcy, which should be viewed as a minor positive
> and monitored for further improvement.

Agreed, thanks!

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2008-01-03 US Economic Releases

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2008-01-03 MBA Mortgage Applications

MBA Mortgage Applications (Dec 28)

Survey n/a
Actual -11/6%
Prior -7.6%
Revised n/a

Last December number – purchase applications normally shoot back up in January.

2008-01-03 Challenger Job Cuts YoY

Challenger Job Cuts YoY (Dec)

Survey n/a
Actual -18.7%
Prior -4.7%
Revised n/a

Graph looks OK.

2008-01-03 ADP Employment Change

ADP Employment Change (Dec)

Survey 33K
Actual 40K
Prior 189K
Revised 173K

A touch better than expected, trending down some, but fed thinks there are fewer people left to hire. This is a real number as ADP reports the actual number of people on its payroll system.

2008-01-03 Initial Jobless Claims

Initial Jobless Claims

Survey 345K
Actual 336K
Prior 349K
Revised 357K

This kind of drop means there is no weakness indicated here.

2008-01-03 Continuing Claims

Continuing Claims (Dec 22)

2008-01-03 Continuing Claims from 1980

Continuing Claims since 1980

Survey 2675K
Actual 2761K
Prior 2713K
Revised 2715K

Up some, but the long term graph looks fine.

2008-01-03 Factory Orders

Factory Orders (Nov)

Survey 0.5%
Actual 1.5%
Prior 0.5%
Revised 0.7%

No weakness here.

2008-01-03 Total Vehicle Sales

Total Vehicle Sales (Dec)

Survey 16.0M
Actual 16.3M
Prior 16.2M
Revised n/a

Still on the soft side, but no disaster.

2008-01-03 Domestic Vehicle Sales

Domestic Vehicle Sales (Dec)

Survey 12.2M
Actual 12.5M
Prior 12.4M
Revised n/a

As above.

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January 2008 update

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The following sums up the mainstream approach:

Low inflation is a NECESSARY condition for optimal long term growth and employment.

There is not trade off. If a CB acts to support near term output, and allows inflation to rise, the longer term cost to output of bringing down that inflation is far higher than any near term gains in output.

The evidence of excessive demand is prices. So the way the mainstream sees it, currently demand is sufficiently high to support today’s prices of fuel, food, gold, and other commodities, as well as CPI in general.

In the first instance, price increases are ‘relative value stories.’ The negative supply shocks of food, fuel, and import prices are shifts in relative value, and not inflation. However, should the Fed ‘accommodate’ those price increases, and allow inflation expectations to elevate and other prices to ‘catch up,’ the Fed has allowed a ‘relative value story’ to become an ‘inflation story.’

Therefore, to optimize long term employment and growth, the Fed needs only to conduct a monetary policy that targets low inflation, and let markets function to optimize long term employment and growth.

There’s the rub. The Fed has been concerned about ‘market functioning.’ The mainstream understanding assumes markets are
‘functioning’ (and competitive, but that’s another story). If markets are not functioning there is no channel to translate low inflation to optimal growth and employment.

Hence the Fed concern for ‘market functioning.’ Unfortunately, there isn’t much in the literature to help them. There’s nothing, for example, that tells them what transactions volumes, bid/offer spreads, credit spreads, etc. are evidence of sufficient ‘market functioning.’ Nor do they have studies on which markets need to function to support long term output and growth. For example, are the leveraged buyout markets, CMO and other derivative markets supportive of optimal growth? And what about markets such as the sub prime markets that added to demand for housing, but may be unsustainable as borrowers can’t support payment demands? And meaning all they did was get housing subsidized by investor’s shareholder equity.

On Sept 18 the Fed cut rates 50 basis points citing risks to ‘market functioning.’ Given the above, this was a logical concern,
particularly given the lack of experience with financial markets of the FOMC members.

In the latest minutes, a different story seems to be emerging. Markets are now pricing in rate cuts based on the risks of a weakening economy per se.

While it is generally agreed that markets are now functioning (there are bid/offer spreads, and sufficient trading is taking place to
support the economy at modest levels of real growth) the concern now is that higher prices for fuel, food, and imports, higher credit thresholds, falling home prices, and a host of other non ‘market functioning’ issues, might reduce growth and employment to recession levels.

This view has no support in mainstream economic theory. As above, mainstream math- and lots of it- concludes that any level of demand that is driving inflation higher is too much demand for optimal long term growth and employment. If that means recession in the near term, so be it. The alternative is perhaps a bit more short term growth, but at the risk of accelerating inflation which will cost far more to bring under control than any possible short term gains. As Fed Governor Kohn stated, “We learned that lesson in the 70’s and we’re not going to make that mistake again.”

To be continued.

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