DXY and exports


[Skip to the end]

2008-06-03 Dollar Index vs US Exports

Dollar Index vs US Exports

Right – seems to me the dollar will fall until it’s at a level where the trade gap goes to about zero. So even though exports are way up and the trade gap down, there could be a lot more to go.

A nation can only run a trade deficit to the extent non-residents (governments and private sector agents) desire to net accumulate its financial assets (or buy its domestic assets such as real estate).

Seems to me Paulson, Bush, and Bernanke have successfully kept the world’s CBs, monetary authorities, and portfolio managers from actively accumulating USD financial assets.

Doesn’t seem like jawboning is going to alter foreign ‘savings desires’ apart from short term trading responses.


[top]

Fed minutes – longish version


[Skip to the end]

I cut quite a bit, but still a lot worth a quick read:

In view of continuing strains in interbank and other financial markets, the Committee took up proposals to expand several of the liquidity arrangements that had been put in place in recent months. Chairman Bernanke indicated his intention to increase the overall size of the Term Auction Facility under delegated authority from the Board of Governors, and he proposed increases in the swap lines with the European Central Bank and Swiss National Bank to help address pressures in short-term dollar funding markets.

Still problems with USD funding in the eurozone.

By unanimous votes, the Committee approved the following three resolutions:

The Federal Open Market Committee directs the Federal Reserve Bank of New York to increase the amount available from the System Open Market Account under the existing reciprocal currency arrangement (“swap” arrangement) with the European Central Bank to an amount not to exceed $50 billion. Within that aggregate limit, draws of up to $25 billion are hereby authorized. The current swap arrangement shall be extended until January 30, 2009, unless further extended by the Federal Open Market Committee.

The Federal Open Market Committee directs the Federal Reserve Bank of New York to increase the amount available from the System Open Market Account under the existing reciprocal currency arrangement (“swap” arrangement) with the Swiss National Bank to an amount not to exceed $12 billion. Within that aggregate limit, draws of up to $6 billion are hereby authorized. The current swap arrangement shall be extended until January 30, 2009, unless further extended by the Federal Open Market Committee.

The information reviewed at the April meeting, which included the advance data on the national income and product accounts for the first quarter, indicated that economic growth had remained weak so far this year. Labor market conditions had deteriorated further, and manufacturing activity was soft. Housing activity had continued its sharp descent, and business spending on both structures and equipment had turned down. Consumer spending had grown very slowly, and household sentiment had tumbled further. Core consumer price inflation had slowed in recent months, but overall inflation remained elevated.

The stronger than expected April numbers hadn’t been released yet, including the drop in the unemployment rate to 5.0%.

Although industrial production rose in March, production over the first quarter as a whole was soft, having declined, on average, in January and February. Gains in manufacturing output of consumer and high-tech goods in March were partially offset by a sharp drop in production of motor vehicles and parts and by ongoing weakness in the output of construction-related industries. The output of utilities rebounded in March following a weather-related drop in February, and mining output moved up after exhibiting weakness earlier in the year. The factory utilization rate edged up in March but stayed well below its recent high in the third quarter of 2007.

Real consumer spending expanded slowly in the first quarter. Real outlays on durable goods, including automobiles, were estimated to have declined in March, but expenditures on nondurable goods were thought to have edged up, boosted by a sizable increase in real outlays for gasoline. For the quarter as a whole, however, real expenditures on both durable and nondurable goods declined. Real disposable personal income also grew slowly in the first quarter, restrained by rapidly rising prices for energy and food. The ratio of household wealth to disposable income appeared to have moved down again in the first quarter, damped by the appreciable net decline in broad equity prices over that period and by further reductions in house prices. Measures of consumer sentiment fell sharply in March and April; the April reading of consumer sentiment published in the Reuters/University of Michigan Survey of Consumers was near the low levels posted in the early 1990s.

That’s how it goes in an export driven economy. They haven’t recognized that yet:

Residential construction continued its rapid contraction in the first quarter. Single-family housing starts maintained their steep downward trajectory in March, and starts of multifamily homes declined to the lower portion of their recent range. Sales of new single-family homes declined in February to a very low rate and dropped further in March. Even though production cuts by homebuilders helped to reduce the level of inventories at the end of February, the slow pace of sales caused the ratio of unsold new homes to sales to increase further. Sales of existing homes remained weak, on average, in February and March, and the index of pending sales agreements in February suggested continued sluggish activity in coming months. The recent softening in residential housing demand was consistent with reports of tighter credit conditions for both prime and nonprime borrowers.

Recent signs of housing stabilizing haven’t materialized yet.

The U.S. international trade deficit widened in February. Imports rose sharply, more than offsetting continued robust growth of exports. Most major categories of non-oil imports increased in February, and imports of natural gas, automobiles, and consumer goods surged. Imports of services continued to rise at a robust pace. By contrast, oil imports moved down. Increases in exports in February were concentrated in agricultural goods, automobiles, and industrial supplies, particularly fuels. Exports of capital goods declined for the second consecutive month, with weakness evident across a wide range of products.

The March numbers weren’t out yet, and they bounced back strongly, resulting in upward revisions to Q1 GDP.

Real economic growth in the major advanced foreign economies was estimated to have slowed further in the first quarter and consumer and business sentiment was generally down. In Japan, business sentiment fell significantly and indicators of investment remained weak. In the euro area, growth was estimated to have remained subdued in the first quarter, with Germany and France faring better than Italy and Spain. Growth in the United Kingdom slowed in the first quarter, as credit conditions tightened. Available data for Canada indicated a continued substantial drag from exports in the first quarter, although domestic demand appeared relatively robust. In emerging market economies, economic growth slowed some in the fourth quarter and was estimated to have held about steady in the first quarter. In emerging Asia, real economic growth was estimated to have picked up in the first quarter from a robust pace in the fourth quarter, led by brisk expansions in China and Singapore. Growth in other emerging Asian economies generally remained subdued. The pace of expansion in Latin America likely declined some in the first quarter, largely because the Mexican economy slowed in the wake of softer growth in the United States.

Headline inflation in the United States was elevated in March. Although the increase in food prices slowed in March relative to earlier in the year, energy prices rose sharply. Excluding these categories, core inflation rose at a relatively subdued rate again in March. The core personal consumption expenditures (PCE) price index increased at a somewhat more moderate rate in the first quarter than in the fourth quarter of 2007. Survey measures of households’ expectations for year-ahead inflation rose further in early April, but survey measures of longer-term inflation expectations moved relatively little. Average hourly earnings increased in March at a somewhat slower pace than in January and February. This wage measure rose significantly less over the 12 months that ended in March than in the previous 12 months. The employment cost index for hourly compensation continued to rise at a moderate rate in the first quarter.

Food and energy have since gone up further than forecast at the meeting.

At its March 18 meeting, the Federal Open Market Committee (FOMC) lowered its target for the federal funds rate 75 basis points, to 2-1/4 percent. In addition, the Board of Governors approved a decrease of 75 basis points in the discount rate, to 2-1/2 percent. The Committee’s statement noted that recent information indicated that the outlook for economic activity had weakened further; growth in consumer spending had slowed, and labor markets had softened. It also indicated that financial markets remained under considerable stress, and that the tightening of credit conditions and the deepening of the housing contraction were likely to weigh on economic growth over the next few quarters. Inflation had been elevated, and some indicators of inflation expectations had risen, but the Committee expected inflation to moderate in coming quarters, reflecting a projected leveling-out of energy and other commodity prices and an easing of pressures on resource utilization.

Which didn’t happen.

Still, the Committee noted that uncertainty about the inflation outlook had increased, and that it would be necessary to continue to monitor inflation developments carefully. The Committee said that its action, combined with those taken earlier, including measures to foster market liquidity, should help to promote moderate growth over time and to mitigate the risks to economic activity. The Committee noted, however, that downside risks to growth remained, and indicated that it would act in a timely manner as needed to promote sustainable economic growth and price stability.

Conditions in U.S. financial markets improved somewhat, on balance, over the intermeeting period, but strains in some short-term funding markets increased. Pressures on bank balance sheets and capital positions appeared to mount further, reflecting additional losses on asset-backed securities and on business and household loans. Against this backdrop, term spreads in interbank funding markets and spreads on commercial paper issued by financial institutions widened significantly. Financial institutions continued to tap the Federal Reserve’s credit programs. Primary credit borrowing picked up noticeably after March 16, when the Federal Reserve reduced the spread between the primary credit rate and the target federal funds rate to 25 basis points. Demand for funds from the Term Auction Facility stayed high over the period. In addition, the Primary Dealer Credit Facility drew substantial demand through late March, although the amount outstanding subsequently declined somewhat. Early in the period, historically low interest rates on Treasury bills and on general-collateral Treasury repurchase agreements indicated a considerable demand for safe-haven assets. However, Federal Reserve actions that increased the availability of Treasury securities to the public apparently helped to improve conditions in those markets. In five weekly auctions beginning on March 27, the Term Securities Lending Facility provided a substantial volume of Treasury securities in exchange for less-liquid assets. Yields on short-term Treasury securities and Treasury repurchase agreements moved higher, on balance, following these auctions; nonetheless, “haircuts” applied by lenders on non-Treasury collateral remained elevated, and in some cases increased somewhat, toward the end of the period.

In longer-term credit markets, yields on investment-grade corporate bonds rose, but their spreads relative to Treasury securities decreased a bit from recent multiyear highs. In contrast, yields on speculative-grade issues dropped, and their spreads relative to Treasury yields narrowed significantly. Gross bond issuance by nonfinancial firms was robust in March and the first half of April and included a small amount of issuance by speculative-grade firms. Supported by increases in business and residential real estate loans, commercial bank credit expanded briskly in March despite the report of tighter lending conditions in the Senior Loan Officer Opinion Survey on Bank Lending Practices conducted in April. Part of the strength in commercial and industrial loans was apparently due to increased utilization of existing credit lines, the pricing of which reflects changes in lending policies only with a lag.

Also, though standards were ‘tightened’, that doesn’t mean most borrowers can’t meet those standards.

Some banks surveyed in April reported that they had started to take actions to limit their exposure to home equity lines of credit, draws on which had grown rapidly in recent months. After having tightened considerably in March, conditions in the conforming segment of the residential mortgage market recovered somewhat. Spreads of rates on conforming residential mortgages over those on comparable-maturity Treasury securities decreased, and credit default swap premiums for the government-sponsored enterprises declined substantially. Broad stock price indexes increased markedly over the intermeeting period, mainly in response to earnings reports and announcements of recapitalizations from major financial institutions that evidently lessened investors’ concerns about the possibility of severe difficulties materializing at those firms.

Conditions in the money markets of major foreign economies remained strained, particularly in the United Kingdom and the euro area. Term interbank funding spreads rose in these areas, despite steps taken by their central banks to help ease liquidity pressures. Yields on sovereign debt in the advanced foreign economies moved up in a range that was about in line with the increases in comparable Treasury yields in the United States. The trade-weighted foreign exchange value of the dollar against major currencies rose.

The dollar is back down now.

M2 expanded briskly again in March, as households continued to seek the relative liquidity and safety of liquid deposits and retail money market mutual funds. The increases in these components were also supported by declines in opportunity costs stemming from monetary policy easing.

Over the intermeeting period, the expected path of monetary policy over the next year as measured by money market futures rates moved up significantly on net, apparently because economic data releases and announcements by large financial firms imparted greater confidence among investors about the prospects for the economy’s performance in coming quarters. Futures rates also moved up in response to both the Committee’s decision to lower the target for the federal funds rate by 75 basis points at the March 18 meeting, which was a somewhat smaller reduction than market participants had expected, and the Committee’s accompanying statement, which reportedly conveyed more concern about inflation than had been anticipated.

Yes.

The subsequent release of the minutes of the March FOMC meeting elicited limited reaction. Consistent with the higher expected path for policy and easing of safe-haven demands, yields on nominal Treasury coupon securities rose substantially over the period, and the Treasury yield curve flattened. Measures of inflation compensation for the next five years derived from yields on inflation-indexed Treasury securities were quite volatile around the time of the March FOMC meeting and on balance increased somewhat over the intermeeting period, although they remained in the lower portion of their range over the past several months. Measures of longer-term inflation compensation declined, returning to around the middle of their recent elevated range.

They seem to continue to give these quite a bit of weight.

In the forecast prepared for this meeting, the staff made little change to its projection for the growth of real gross domestic product (GDP) in 2008 and 2009. The available indicators of recent economic activity had come in close to the staff’s expectations and had continued to suggest that a substantial softening in economic activity was under way. The staff projection pointed to a contraction of real GDP in the first half of 2008 followed by a modest rise in the second half of this year, aided in part by the fiscal stimulus package.

Doesn’t look like there will be a contraction; so, GDP is likely to be higher than staff forecasts.
The forecast showed real GDP expanding at a rate somewhat above its potential in 2009, reflecting the impetus from cumulative monetary policy easing, continued strength in net exports, a gradual lessening in financial market strains, and the waning drag from past increases in energy prices. Despite this pickup in the pace of activity, the trajectory of resource utilization anticipated through 2009 implied noticeable slack. The projection for core PCE price inflation in 2008 as a whole was unchanged; it was reduced a bit over the first half of the year to reflect the somewhat lower-than-expected readings of recent core PCE inflation and raised a bit over the second half of the year to incorporate the spillover from larger-than-anticipated increases in prices of crude oil and non-oil imports since the previous FOMC meeting.
Here’s where the subsequent talk of headline measures passing into core was discussed.

The forecast of headline PCE inflation in 2008 was revised up in light of the further run-up in energy prices and somewhat higher food price inflation; headline PCE inflation was expected to exceed core PCE price inflation by a considerable margin this year. In view of the projected slack in resource utilization in 2009 and flattening out of oil and other commodity prices, both core and headline PCE price inflation were projected to drop back from their 2008 levels, in line with the staff’s previous forecasts.

They are relying on slack in 2009 to bring down this year’s inflation.

In conjunction with the FOMC meeting in April, all meeting participants (Federal Reserve Board members and Reserve Bank presidents) provided annual projections for economic growth, the unemployment rate, and inflation for the period 2008 through 2010. The projections are described in the Summary of Economic Projections, which is attached as an addendum to these minutes.

These were all before subsequent ‘better than expected’ releases, higher crude prices, and a falling USD.

In their discussion of the economic situation and outlook, FOMC participants noted that the data received since the March FOMC meeting, while pointing to continued weakness in economic activity, had been broadly consistent with their expectations. Conditions across a number of financial markets were judged to have improved over the intermeeting period, but financial markets remained fragile and strains in some markets had intensified. Although participants anticipated that further improvement in market conditions would occur only slowly and that some backsliding was possible, the generally better state of financial markets had caused participants to mark down the odds that economic activity could be severely disrupted by a further substantial deterioration in the financial environment.

Their concern of systematic tail risk has gone down substantially.

Economic activity was anticipated to be weakest over the next few months, with many participants judging that real GDP was likely to contract slightly in the first half of 2008. GDP growth was expected to begin to recover in the second half of this year, supported by accommodative monetary policy and fiscal stimulus, and to increase further in 2009 and 2010. Views varied about the likely pace and vigor of the recovery through 2009, although all participants projected GDP growth to be at or above trend in 2010. Incoming information on the inflation outlook since the March FOMC meeting had been mixed. Readings on core inflation had improved somewhat, but some of this improvement was thought likely to reflect transitory factors, and energy and other commodity prices had increased further since March. Total PCE inflation was projected to moderate from its current elevated level to between 1-1/2 percent and 2 percent in 2010, although participants stressed that this expected moderation was dependent on food and energy prices flattening out and critically on inflation expectations remaining reasonably well anchored.

As per Kohn’s latest speech, they have seen these inflation expectations begin to elevate.

Conditions across a number of financial markets had improved since the previous FOMC meeting. Equity prices and yields on Treasury securities had increased, volatility in both equity and debt markets had ebbed somewhat, and a range of credit risk premiums had moved down. Participants noted that the better tone of financial markets had been helped by the apparent willingness and ability of financial institutions to raise new capital. Investors’ confidence had probably also been buoyed by corporate earnings reports for the first quarter, which suggested that profit growth outside of the financial sector remained solid,

Yes, they have noted that outside the financial sector and housing the economy looks pretty good.

and also by the resolution of the difficulties of a major broker-dealer in mid-March.

Probably Bear Stearns.

NOTE: They didn’t refer to it by name.

Moreover, the various liquidity facilities introduced by the Federal Reserve in recent months were thought to have bolstered market liquidity and aided a return to more orderly market functioning. But participants emphasized that financial markets remained under considerable stress, noted that the functioning of many markets remained impaired, and expressed concern that some of the recent recovery in markets could prove fragile. Strains in short-term funding markets had intensified over the intermeeting period, in part reflecting continuing pressures on the liquidity positions of financial institutions. Despite a narrowing of spreads on corporate bonds, credit conditions were seen as remaining tight. The Senior Loan Officer Opinion Survey on Bank Lending Practices conducted in April indicated that banks had tightened lending standards and pricing terms on loans to both businesses and households. Participants stressed that it could take some time for the financial system to return to a more normal footing, and a number of participants were of the view that financial headwinds would probably continue to restrain economic activity through much of next year. Even so, the likelihood that the functioning of the financial system would deteriorate substantially further with significant adverse implications for the economic outlook was judged by participants to have receded somewhat since the March FOMC meeting.
The housing market had continued to weaken since the previous meeting, and participants saw little indication of a bottoming out in either housing activity or prices. Housing starts and the demand for new homes had declined further, house prices in many parts of the country were falling faster than they had towards the end of 2007, and inventories of unsold homes remained quite elevated. A small number of participants reported tentative signs that housing activity in a few areas of the country might be beginning to pick up, and a narrowing of credit risk spreads on AAA indexes of sub-prime mortgages in recent weeks was also noted. Nonetheless, the outlook for the housing market remained bleak, with housing demand likely to be affected by restrictive conditions in mortgage markets, fears that house prices would fall further, and weakening labor markets. The possibility that house prices could decline by more than anticipated, and that the effects of such a decline could be amplified through their impact on financial institutions and financial markets, remained a key source of downside risk to participants’ projections for economic growth.

There have been subsequent glimmers of hope that housing has stabilized and may be turning.

Growth in consumer spending appeared to have slowed to a crawl in recent months and consumer sentiment had fallen sharply. The pressure on households’ real incomes from higher energy prices and the erosion of wealth resulting from continuing declines in house prices likely contributed to the deceleration in consumer outlays. Reports from contacts in the banking and financial services sectors indicated that the availability of both consumer credit and home equity lines had tightened considerably further in recent months and that delinquency rates on household credit had continued to drift upwards. Consumer sentiment and spending had also been held down by the softening in labor markets–nonfarm payroll employment had fallen for the third consecutive month in March and the unemployment rate had moved up. The restraint on spending emanating from weakness in labor markets was expected to increase over coming quarters, with participants projecting the unemployment rate to pick up further this year and to remain elevated in 2009.

Subsequently, the unemployment rate fell.

Consumption spending was likely to be supported in the near term by the fiscal stimulus package, which was expected to boost spending temporarily in the middle of this year. Some participants suggested that the weak economic environment could increase the propensity of households to use their tax rebates to pay down existing debt and so might diminish the impact of the package. However, it was also noted that the tightening in credit availability might mean a significant number of households may be credit constrained and this might increase the proportion of the rebates that is spent. The timing and magnitude of the impact of the stimulus package on GDP was also seen as depending on the extent to which the boost to consumption spending is absorbed by a temporary run-down in firms’ inventories or by an increase in imports rather than by an expansion in domestic output.

The jurry is still out on this. My guess is the rebates will add more to GDP than forecasted.

The outlook for business spending remained decidedly downbeat. Indicators of business sentiment were low, and reports from business contacts suggested that firms were scaling back their capital spending plans. Several participants reported that uncertainty about the economic outlook was leading firms to defer spending projects until prospects for economic activity became clearer. The tightening in the supply of business credit was also seen as holding back investment, with some firms apparently reluctant to reduce their liquidity positions in the current environment. Spending on nonresidential construction projects continued to slow, although the extent of that slowing varied across the country. A few participants reported that the commercial real estate market in some areas remained relatively firm, supported by low vacancy rates.

Yes.

The strength of U.S. exports remained a notable bright spot. Growth in exports, which had been supported by solid advances in foreign economies and by declines in the foreign exchange value of the dollar, had partially insulated the output and profits of U.S. companies, especially those in the manufacturing sector, from the effects of weakening domestic demand. Several participants voiced concern, however, that the pace of activity in the rest of the world could slow in coming quarters, suggesting that the impetus provided from net exports might well diminish.

The March numbers subsequently released showed further acceleration of exports.

The information received on the inflation outlook since the March FOMC meeting had been mixed. Recent readings on core inflation had improved somewhat, although participants noted that some of that improvement probably reflected transitory factors. Moreover, the increase in crude oil prices to record levels, together with rapid increases in food and import prices in recent months, was likely to put upward pressure on inflation over the next few quarters. Prices embedded in futures contracts continued to point to a leveling-off of energy and commodity prices.

Still misreading the info implied from futures prices:

Although these futures contracts probably remained the best basis for projecting movements in commodity prices, participants emphasized the considerable uncertainty attending the likely path of commodity prices and cautioned that commodity prices in recent years had often advanced more quickly than had been implied by futures contracts. Several participants reported that business contacts had expressed growing concerns about the increase in their input costs and that there were signs that an increasing number of firms were seeking to pass on these higher costs to their customers in the form of higher prices. Other participants noted, however, that the extent of the pass-through of higher energy and food prices to core retail prices appeared relatively limited to date, and that profit margins in the nonfinancial sector remained reasonably high, suggesting that there was some scope for firms to absorb cost increases without raising prices. Available data and anecdotal reports indicated that gains in labor compensation remained moderate, and some participants suggested that wage growth was unlikely to pick up sharply in coming quarters if, as anticipated, labor markets remained relatively soft. However, several participants were of the view that wage inflation tended to lag increases in prices and so may not provide a useful guide to emerging price pressures.

Agreed!

On balance, participants expected the recent increases in oil and food prices to continue to boost overall consumer price inflation in the near term; thereafter, total inflation was projected to moderate, with all participants expecting total PCE inflation of between 1-1/2 percent and 2 percent by 2010. Participants stressed that the expected moderation in inflation was dependent on the continued stability of inflation expectations.

One can’t overstate the weight they all put on inflation expections, which are now seen as elevating.

A number of participants voiced concern that long-term inflation expectations could drift upwards if headline inflation remained elevated for a protracted period or if the recent substantial policy easing was misinterpreted by the public as suggesting that Committee members had a greater tolerance for inflation than previously thought.

This was again expressed recently by Vice Chair Kohn in his speech.

The possibility that inflation expectations could increase was viewed as a key upside risk to the inflation outlook. However, participants emphasized that appropriate monetary policy, combined with effective communication of the Committee’s commitment to price stability, would mitigate this risk.

‘Appropriate monetary policy’ opens the door for rate hikes.

Participants stressed the difficulty of gauging the appropriate stance of policy in current circumstances. Some participants noted that the level of the federal funds target, especially when compared with the current rate of inflation, was relatively low by historical standards. Even taking account of current financial headwinds, such a low rate could suggest that policy was reasonably accommodative. However, other participants observed that the pronounced strains in banking and financial markets imparted much greater uncertainty to such assessments and meant that measures of the stance of policy based on the real federal funds rate were not likely to provide a reliable guide in the current environment. Several participants expressed the view that the easing in monetary policy since last fall had not as yet led to a loosening in overall financial conditions, but rather had prevented financial conditions from tightening as much as they otherwise would have in response to escalating strains in financial markets. This view suggested that the stimulus from past monetary policy easing would be felt mainly as conditions in financial markets improved.

Seems there are three ‘camps’ on this point.

In the Committee’s discussion of monetary policy for the intermeeeting period, most members judged that policy should be eased by 25 basis points at this meeting. Although prospects for economic activity had not deteriorated significantly since the March meeting, the outlook for growth and employment remained weak and slack in resource utilization was likely to increase. An additional easing in policy would help to foster moderate growth over time without impeding a moderation in inflation.

There hasn’t been any forward looking sign of moderation since that meeting.

Moreover, although the likelihood that economic activity would be severely disrupted by a sharp deterioration in financial markets had apparently receded, most members thought that the risks to economic growth were still skewed to the downside. A reduction in interest rates would help to mitigate those risks. However, most members viewed the decision to reduce interest rates at this meeting as a close call.

Interesting statement!

The substantial easing of monetary policy since last September, the ongoing steps taken by the Federal Reserve to provide liquidity and support market functioning, and the imminent fiscal stimulus would help to support economic activity. Moreover, although downside risks to growth remained, members were also concerned about the upside risks to the inflation outlook, given the continued increases in oil and commodity prices and the fact that some indicators suggested that inflation expectations had risen in recent months. Nonetheless, most members agreed that a further, modest easing in the stance of policy was appropriate to balance better the risks to achieving the Committee’s dual objectives of maximum employment and price stability over the medium run.
The Committee agreed that that the statement to be released after the meeting should take note of the substantial policy easing to date and the ongoing measures to foster market liquidity. In light of these significant policy actions, the risks to growth were now thought to be more closely balanced by the risks to inflation. Accordingly, the Committee felt that it was no longer appropriate for the statement to emphasize the downside risks to growth. Given these circumstances, future policy adjustments would depend on the extent to which economic and financial developments affected the medium-term outlook for growth and inflation. In that regard, several members noted that it was unlikely to be appropriate to ease policy in response to information suggesting that the economy was slowing further or even contracting slightly in the near term, unless economic and financial developments indicated a significant weakening of the economic outlook.

In other words, no thought of more rate cuts without that change in outlook.

Votes for this action: Messrs. Bernanke, Geithner, Kohn, Kroszner, and Mishkin, Ms. Pianalto, Messrs. Stern and Warsh.

Votes against this action: Messrs. Fisher and Plosser.

Messrs. Fisher and Plosser dissented because they preferred no change in the target federal funds rate at this meeting. Although the economy had been weak, it had evolved roughly as expected since the previous meeting. Stresses in financial markets also had continued, but the Federal Reserve’s liquidity facilities were helpful in that regard and the more worrisome development in their view was the outlook for inflation. Rising prices for food, energy, and other commodities; signs of higher inflation expectations; and a negative real federal funds rate raised substantial concerns about the prospects for inflation. Mr. Plosser cited the recent rapid growth of monetary aggregates as additional evidence that the economy had ample liquidity after the aggressive easing of policy to date. Mr. Fisher was concerned that an adverse feedback loop was developing by which lowering the funds rate had been pushing down the exchange value of the dollar, contributing to higher commodity and import prices, cutting real spending by businesses and households, and therefore ultimately impairing economic activity. To help prevent inflation expectations from becoming unhinged, both Messrs. Fisher and Plosser felt the Committee should put additional emphasis on its price stability goal at this point, and they believed that another reduction in the funds rate at this meeting could prove costly over the longer run.

By notation vote completed on April 7, 2008, the Committee unanimously approved the minutes of the FOMC meeting held on March 18, 2008.


[top]

FT: Germany leans towards tax cut


[Skip to the end]

Germany leans towards tax cut

by Bertrand Benoit

(FT) Michael Glos said the government’s budget pledge “should not stand in isolation above all other [goals]”. The minister said he “fully supported” a plan by his Christian Social Union to cut income tax by €28bn ($43bn, £22bn) until 2012 without an equivalent cut in spending. The government last week slashed its tax revenue estimate by more than €5bn for this year and next, yet advocates of fiscal rectitude are becoming a minority as the CSU, the CDU – its sister party headed by Chancellor Angela Merkel – and the Social Democratic party, its partner in the ruling alliance, seek to please voters ahead of next year’s election.

While this would increase employment and output, it would also add nominal aggregate demand as well as add to the ‘funding pressure’ of the national government. In the current environment, this would add support to nominal prices as well as undermine the credit quality of the government.

What’s happening is much of the mainstream believes inflation is a function of monetary policy and not fiscal policy, so they see this as a way to support the economy without inflation.

Same happened in the US with Bernanke pushing Congress for the fiscal package that’s now kicking in and adding to price pressures. In general, the FOMC holds the mainstream belief that ‘true inflation’ is a function of only monetary policy.


[top]

2008-05-03 Weekend update (in brief)


[Skip to the end]

2008-05-03 Real GDP

No recession here, and Q1 likely to be revised higher when March trade numbers come out.

Q3 could be 2% depending on the multiplier from the fiscal package, and by Q3 other government spending will be kicking in for the elections and housing is unlikely to be subtracting from GDP. It could even be adding by then.

As suspected, the current weak housing market has been offset by strong exports.

Financial sector losses have nothing to do with GDP unless they somehow reduce aggregate demand.

The prime suspect was the credit channel, but so far the evidence shows only limited damage due to tighter credit conditions, and not the downward spiral feared by the Fed and many other private economists.

2008-05-03 Capacity Utilization, ISM Manufacturing

On the soft side, but no recession.

2008-05-03 Personal Spending, Personal Income

The consumer is muddling through as best as can be expected in an export economy.

2008-05-03 New Home Sales Median Prices, New Home Suppy (Actual Units)

Median prices are soft and may or may not have bottomed, as actual inventories have worked their way down to relatively normal levels for a relatively normal sales pace (which we don’t have yet).

2008-05-03 NAHB Housing Index, NAHB Present Sales Index, NAHB Future Sales Index, Conference Board Home Buying Intentions

The bulk of the adjustment may have been bottoming around October/November.

2008-05-03 Housing Starts, Building Permits

Low starts have reduced supply as builders and buyers remain cautious.

2008-05-03 Government Spending, Government Revenue

Government spending is roaring back and added nicely to Q1 GDP (March print above has timing issues and wasn’t functionally as low as indicated).

Revenue also holding up, indicating no recession yet.

2008-05-03 Export Prices, U. of Michigan 12 Month Inflation Expectations

Every price chart is looking higher, and expectations have elevated, and the Fed keeps cutting rates. Who would’ve thought?

Fisher and Plosser make the mainstream case and are outvoted.

2008-05-03 Employment Cost Index

Wages remain ‘well contained’.

(If you don’t count import prices from China..)

2008-05-03 Import Prices ex. Petro

Globalization is now inflationary.

2008-05-03 U. of Michigan Confidence

All the confidence surveys look about this weak, and at recession type levels, and about 90% of voters think we are in a recession.

American’s aren’t used to an export economy with declining real terms of trade – a mercantilist concept publicly supported by Bernanke and Paulson.

And they don’t seem to like it.


[top]

Changing Tides

I’ve been thinking that when the Fed turns its attention to inflation it will find itself way behind that curve, which it is by any mainstream standard, and that the curve then gets negative from a year or two out as markets anticipate rate hikes followed by falling inflation and rate cuts.

Didn’t know exactly how it would get from here to there, how long it would take or exactly when it would happen.

I never thought the Fed would let it go this far. Especially Governor Kohn, who has been through this before in the 1970s with Burns, Miller, and Volcker. This FOMCs inflation tolerance lasted a lot longer than I expected, even with a weak economy and perceived systemic risk.

Won’t be long before the mainstream comes down hard on this FOMC for letting the inflation cat out of the bag with a high risk, untested, counter theory strategy of aggressively cutting into a triple negative supply shock. The mainstream will see it as a ‘hail Mary’ move. If it works, fine, if not it was a foolish error with a major price to pay to fix it.

Maybe they just got what will turn out to be overconfident in their inflation fighting ability. Kind of a ‘we know how to do that and can do it anytime’ attitude.

Wrong. They will soon find out it is not so easy.

Maybe they got confused and saw the tail risk as that of the gold standard era when there were real supply side constraints to money to deal with.

Also, they probably blamed the whole 1970’s thing on labor unions; so, maybe they got blind sided this time because they thought without unions wages would be ‘well contained’ and therefore there would be no inflation.

Wrong on that score as well. It was about oil before, and it is about oil now.

And the fact is, they have no tools for fighting inflation. They think they do (hiking rates), but higher rates just make it worse by raising costs and jacking up rentier incomes. (Incomes of savers who do not work or produce = more demand and no supply)

The inflation broke in the early 80’s only because of a supply response of about 15 million barrels of crude per day that buried OPEC and caused prices to collapse for almost 20 years. (And even during the 20 years of low oil prices and falling imported prices inflation still averaged around 3%.)

That kind of supply response is not going to happen in the near future. I expect the Saudis to keep hiking and inflation to keep getting worse no matter what the Fed does. It is payback time for them from being humiliated in the 1980s, and they are also at ideological war with us whether we know it or not.

Markets might have a false start or two with the interest rate response and flattening curve, just to not make it too easy.

Also, as before, there could be an equity pullback when it is sensed the Fed is going to seriously fight inflation with hikes designed to keep a sufficient output gap to bring inflation increases down.

And along the way everything goes up, including housing prices, during a major cost push inflation. Even with low demand. Just look at all the weak emerging market nations that have had major inflations with weak demand, high rates, etc. etc.

Money (USD)

My take on the USD:

It was at a level based on foreigners wanting to accumulate $70 billion per month which also = the US trade gap (accounting identity).

Most of that desire to accumulate came from foreign CBs trying to support their exporters, oil producers accumulating USD financial assets, and foreign portfolios allocating some percentage of assets to USD assets.

Paulson cut off the CBs calling the currency manipulators and outlaws.

Bush cut off the oil producers by being perceived to be conducting a holy war.

Bernanke scared off the portfolio managers with what looks to them like an ‘inflate your way out of debt’ policy.

And US pension funds are diversifying out of USD into passive commodities and foreign securities.  Looks to me like the desire to accumulate USD overseas is falling towards zero rapidly.

This means they sell us less and buy more of our goods, services, and our real assets.

Volumes’ of non oil imports are falling and of oil imports are flat.

The dollar has gotten low enough for the trade gap to fall from over $70 billion to under $60 billion per month (February was an aberration IMHO).

The dollar will ‘adjust’ until it corresponds with a trade gap that = desired foreign accumulation of USD financial assets.

I see no reason to think the trade gap should not go to zero.

The USD probably has not traded down enough to reflect the zero desire to accumulate USD abroad.

The ECB has serious ideological issues regarding buying of USD.  Not the least of which they don’t want to give the impression that the USD is ‘backing’ the euro, which would be the appearance if they collected USD reserves.

The ECB has an inflation problem, and they believe the strong euro has kept it from being much worse.

The policy ‘shift’ might be the process of ending of US rate cuts at the next meeting by cutting less than expected.

This might first mean only a 25 basis point cut when the market prices in 50 basis points, followed by no cut when markets price in 25 basis points, for example.

This would firm the USD and soften the commodities near term, as after the last 75 basis point cut when markets were pricing 100 basis points.

But this does not change the foreign desires to accumulate USD as direct intervention by the ECB would, for example.

So the adjustment process that gets us to a zero trade gap will continue.

And it will continue to drive up headline CPI with core not far behind.

And US GDP will muddle through in the 0% to +2% range with weak private sector consumption being supported by exports, US government consumption, and moderate investment.

ABC personal finance subcomponent

2008-04-09 ABC News Washington Post US Weekly Personal Finance Index

ABC personal finance subcomponent

Down but not out.

Weakness, but probably no recession as per Bernanke’s latest address before Congress.

Inflation ripping, as Fed staff raises it’s near term forecast.

The Fed ‘fights inflation’ with ‘slack’.

The Fed waiting for slack to be reduced before turning its attention to inflation is illogical at best.

Without the much anticipated further decline in home prices the Fed will find itself that much further ‘behind the inflation curve’.

The Fed needs the housing decline for its models to forecast inflation returning to comfort zones.

Reuters: Bernanke: full effect of rate cuts yet to be felt

by Alister Bull

(Reuters) The full benefit of recent Federal Reserve interest rate cuts has not yet been felt, Fed Chairman Ben Bernanke said Thursday, nodding to a policy lag that may reduce the need for many more rate moves ahead.

Ben Bernanke

CNBC.com

Ben Bernanke


“Further actions will have to depend on how the economy evolves and we are looking of course at both sides of our mandate, growth and inflation,” Bernanke told a U.S. Senate Banking Committee hearing on the rescue of troubled investment bank Bear Stearns.

“The effects of monetary policy are felt over a period of time and we expect to see further positive effects of these policies going forward,” he said.

“I believe we have helped to offset the credit crunch to some extent.” Bernanke acknowledged in testimony Wednesday that there was a risk U.S. growth could contract slightly in the first half of this year, before picking up in the next six months.

On the other hand, recent economic indicators have been mixed, with some signaling that conditions were not getting worse at an accelerating pace and may even be stabilizing.

First time he’s used this kind of language.

Bernanke also stressed Thursday that the Fed was uncomfortable with the current high levels of inflation, while arguing that these pressures should abate in the months ahead.

“The primary reason for the high inflation is rapid increases in the price of globally traded commodities, including crude oil and food,” he said.

Headline U.S. consumer prices rose 4.0 percent in February versus a year ago.

“It is our expectation, which is consistent with the prices seen in futures markets, that these prices will moderate in the coming year and that therefore, overall inflation will tend to slow,” Bernanke said.

“However, we are aware of the uncertainties involved with that and we are obviously going to be watching the situation very carefully,” he added.