Category Archives: Email

Re: The Fed’s dual mandate

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(an email exchange)

On Thu, Jun 12, 2008 at 7:21 PM, Russell wrote:

> The mainstream economists now saying inflation is here to stay. Wow.

Yes, and note this:

Get used to high prices

by Chris Isidore

(CNNMoney.com)But most economists don’t expect the Fed to raise interest rates — its traditional way of combating inflation — until the end of the year at the earliest.

Generally, higher rates cool U.S. economic activity and cut demand for goods and services, which in turn leads to lower prices.

However, the Fed also has a mandate to foster sustainable economic growth. And with the unemployment rate registering its biggest spike in 22 years in May, the Fed is not likely to push rates higher soon, economists said.

They are missing the Fed’s core belief that enables them to meet their dual mandate, that Fisher and others have been repeating:

Low inflation is a necessary condition for optimal growth and employment.

Without that fundamental belief, there is no way to meet both conditions of the dual mandate.

With it, they know, or should know, exactly what to do.


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Re: Mishkin signal?

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>
>   On Tue, Jun 10, 2008 at 8:12 AM, anonymous wrote:
>

>   Fisher’s remark induces one to wonder if Ambrose Evans-Pritchard is
>   correct in stating that Fed policy is now being concocted from Dallas.
>
>   The recent spate of criticism directed at Bernanke and Fed doves by
>   various current and past Fed officials, including Paul Volcker, implies
>   that there has been a revolt within the Fed. Mishkin’s resignation
>   supports the view that the hawks have won.
>
>

Agreed. I’ve been calling it a ‘palace revolt’.

Bernanke’s limit was inflation expectations as anticipated back in August, but he let it go a lot further than I thought he would.

The dallas crew is confused on a lot of things as well, but inflation expectations are the unifying force of the FOMC right now. When Yellen cried uncle, that was my signal.


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Re: Korea

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(an interoffice email)

>
> On Mon, Jun 9, 2008 at 5:05 AM, Sean wrote:
>
> Today Korea announced a plan to spend $10bb to counter the effects of
> rising oil prices. The $100bb will include tax rebates and subsidizing
> power providers. This is with GDP growing at 5.8% ( although expected
> to slow to the mid 4% range and CPI at 4.9% – the package is expected
> to add 0.2% to GDP.
>
> There is no political will in Asia to avoid measures that sustain demand
> for energy related products – subsidy cuts have been very small and the
> outcry loud enough to prevent further meaningful cuts. Inflation is
> ripping in Asia, the second round effects are unavoidable and its going
> to be imported to the US.
>
>

Thanks, looks like Japan cpi break evens have a long way to go!


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Re: Alt A downgrades

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On Wed, Jun 4, 2008 at 12:57 AM, Eric wrote:
>     I guess you have seen this article.
>
>      Primes going down too.
>
>
>      More generally look at the attached graphs, they suggest that IOs and other
>      exotic mortgage are clearly a major cause of the problems, independently of
>      the quality of the loans. I think there is here a pretty good argument to make
>      that non-fixed mortgages, and more especially exotic mortgage have structural
>      characteristics that make them prone to speculative and ponzi structure. The
>      borrowers expect to be able to refinance at one point once interest rate reset or
>      the principal become due. Warren you were saying that proof of ability to pay
>     “libor plus 3 or whatever” was necessary to qualify. This margin of safety
>      (expected ability to pay libor +3 even though now borrower pay only teaser rate)
>      may have been destroyed in several ways.
>
>      – the interest rate may have reset at a higher rate than libor + 3, so that people
>      cannot afford the mortgage anymore.
>
>      – ARMs reinforce the probability of the previous effect, especially when libor when
>      up sky high after the crisis
>
>     – Income of borrowers felt short of expectations, expecially with the economic
>     slowdown (here fiscal policy is clearly a big player)
>
>     – The margin of safety thinned. Maybe previously they had to prove libor + 5 but
>     progressively borrower only had to prove libor + 4 then libor + 3. This would qualify
>      more borrowers and make the deal more sensitive to shock in product and financial
>      markets
>
>      In all this case the affordability of the mortgage is questioned Þ need to refinance Þ
>      if not available then sell the house (short sale or foreclosure). Fixed-rate mortgage
>      eliminate three of the previous reason (only income expectations is a problem).
>
>      Éric

agreed with all.

add to that food and energy prices taking income from home mtg payments, which could be the larger short term effect.

the fed has been taking some heat for this under the theory that the low rates have hurt the $ and thereby hurt the financial sector via the above channel, rather than helped the financial sector via lower rates ‘easing’ conditions via the lower payments channel.

the fed has argued this isn’t the case, insisting the lower rates have helped more than hurt.

also, the fiscal package could soften some of the delinquency increases for a few months.


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Re: Midcurve steepener – The unusual nature of the current USD selloff

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On Thu, May 29, 2008 at 11:58 PM, Deep wrote:
>    The attached charts shows the change in 3M Forwards for the USD curve from its
>    lowest yield point this year (17Mar08) to today.
>   
>    In Chart 1, the changes are compared to two other periods where we had strong
>    selloffs Jun03->Sep03 and Apr07->Jun07.
>   
>    As the chart shows, in the current selloff, the front end has moved approx 180bp
>    (similar in magnitude to the 2003 selloff). However, in contrast to both 2003 and 2007,
>    the forwards beyond 8y have barely moved. In 2003 and 2007, the 10Y3M rate sold off
>    approx 55% as much as the front end. Both of these periods were characterized by
>    mortgage convexity paying.
>   
>    The lack of movement of the back end in the current selloff is leading to an extreme
>    flattening of the yieldcurve compared to prior selloffs.
>   
Hi Deep,

I’m thinking the forwards are anticipating future Fed moves. They see a relatively quick ‘take back’ of the cuts as market functioning returns and we are left with a ‘normal ‘ slowdown.

With cpi looking to move past 5% over the next few months, passthroughs to core increasing, gdp muddling through with strong exports, the Fed will have to decide what the appropriate ‘real rate’ is for what they feel is an appropriate output gap.

The markets will likely believe/discount the Fed will be successful, which means a eurodollar curve that rises sharply with the inflation attack and then tails off after it’s success.

Warren

>   
>    A possible reason for the unusual nature of the current selloff maybe that
>    two offsetting flows characterize it –
>   
>    a) unwind of yieldcurve steepeners by Fixed income, Credit and Equity Funds
>    as part of their delevering out of steepeners – this leads dealers to hedge by
>    paying the front end (less than 5Y) and receive the back end (beyond 10Y).
>   
>    b) paying of 10Y by mortgage convexity hedgers
>   
>    The offsetting flows in the 10Y sector may result in the lack of movement in the
>    forwards beyond 8Y.
>
>     A low-risk way to position against the extreme flattening selloff is through
>    the Midcurve steepener. The trade is to
>    
>     Buy 3160mm Z8expiryZ9 97.00 Call
>    Sell 100mm 12Dec08->10Y 4.25% receiver
>     execute at zero cost
>
>   


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Re: State payrolls suggest a downward revision to April

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>
> the sum of state payrolls just came out for April showing -151k jobs, vs
> the actual prelim rleease earlier this mth of -20k. hints at a potentially
> large downward revision to April payrolls when the May data is released.
>

Thanks!

Plenty of export driven banana republics out there with high unemployment, low wages, falling currencies, high inflation, and high interest rates. Looking like we’re next…


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Re: Federal Reserve Announcement

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On Fri, May 2, 2008 at 9:44 AM, Jeff wrote:

The Fed announced today that, starting May 5th, it was expanding its cash-loan biweekly auctions for banks (Term Auction Facility or TAF) by 50% to $75 billion each auction.  This was the third increase in the four months the program has existed.  The Fed also expanded the collateral accepted for the US Treasuries to include other AAA private-label mbs securities,

good, it should be open to any member bank assets- they are all occ legal anyway

in addition to the residential and commercial mbs and agency CMOs that it already accepts.  It also increased its currency swap facility with the ECB to $50 billion and with the Swiss National Bank to $12 billion and extended the terms through January 2009. 

interesting that the ECB needs more dollars.  if there is going to be a systemic failure it’s in the eurozone.

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Re: WSJ: Greg Ip’s Article

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right, it’s a way to keep the ff rate from falling below target, but does nothing for ‘liquidity’ that’s not already being done.

seems fomc maybe still struggling with ‘monetary operations’

From: Adam
Sent: Tuesday, April 29, 2008 3:59 AM
To: a
Subject: CS: DEF WORTH A READ – GREG IP ARTICLE THAT PROPOSES ANOTHER FED INNOVATION – ALL EXPLAINED BELOW

 

Greg Ip’s piece in the WSJ received some attention today. The piece is titled “ Fed to Consider Paying Interest To Commercial Banks on Reserves” and states that the Fed will discuss this proposal at todays meeting. There is no suggestion that the Fed are about to immediately change the current standard policy of paying zero per-cent for reserve balances, but given that the press had a very good lead on the introduction of the TSLF and PDCF it’s prudent to pay attention. (http://online.wsj.com/article/SB120941973079950909.html?mod=economy_lead_story_lsc)

The reason for changing policy and paying interest on reserve balances is not at first obvious, but is in fact a simple way for the Fed to solve the problem of increasing cash liquidity in the banking system without driving down the Fed effective rate. As the Fed take illiquid asset-backed securities from banks they hand over cash in return. As banks get zero interest on reserve balances that are left with the Fed they quickly seek to place their newly raised cash out into the market, earning a coupon on their investment instead of earning nothing on a reserve balance. As the Fed pay nothing it is in every banks interest to lend any excess balances at rates greater than zero, and what typically happens is that the cash market rate falls dramatically as cash rich banks try and find bids, offering at lower and lower rates until we get close to zero. This is an unwelcome development from the Fed’s perspective as the effective Fed Funds rate that results is often significantly lower than the official Fed target rate. By injecting large amounts of cash liquidity into the system the Fed may actually undermine their own target rate.

Paying a coupon on reserve balances would allow the Fed to inject as much cash via asset-backed repo as they like without needing to worry about driving down the Fed effective cash rate. The Fed would effectively sterilize their own cash injection by placing a guaranteed fixed rate floor on reserve funds, and ensuring that something close to the Fed Funds target rate was achieved. This would mean that the Fed could continue to increase the amount of repo’s that they are willing to undertake and to upsize the auctions without concerns about the effects of huge amounts of excess cash

sloshing around in the system.

Some thoughts to go along with this:

  • Great care needs to be taken in setting guaranteed cash levels. Sometimes unexpected consequences result. Central banks like the RBA and RBNZ  have long operated a cash system which guarantees a floor on overnight rates at a margin below the target rate. This ensures that cash generally trades close to the target rate, or slightly rich to it. Generally local market participants prefer to hold an excess of long balances in the knowledge that cash shortages often occur, but they have a defined downside guarantee. In New Zealand’s case the RBNZ found that banks were hoarding cash to such an extent that the short dated market traded significantly above the OCR target because the banks had a 25bp downside guarantee. It wasn’t until the RBNZ reduced the guaranteed floor substantially that rates traded much closer to target.

 

Banks that get cash from the Fed via the PDCF currently seek to off-load that cash to the street, effectively spreading liquidity to all elements of the banking system, and discouraging the holding of very short term balances which will end of earning 0% if they are not on-lent. If the Fed’s guaranteed rate is not far enough below the FF target rate Banks will simply recycle any excess back to the Fed rather than taking unsecured interbank credit risk. This may leave the smaller regional Banks without direct Fed access short of cash, forcing them to pay a premium instead of getting funds at a discount. The challenge of course is that if the rate is set too far below the Fed Fund’s Target rate the Fed will have the same problem of the effective daily rate printing substantially beneath target. An appropriate margin that the Fed should pay on reserves is likely to be around 50bp below the target rate. This will prevent the Fed effective rate from collapsing, but the 50bp penalty will also incentivise banks to find alternative borrowers wherever possible

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Re: Fannie & Freddie

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>
>   On Mon, Apr 21, 2008 at 9:55 AM, Russell wrote:
>
>   Fannie and Freddie now back 82% of all mortgages in the U.S.,
>   up from only 46% in the second quarter of 2007. If they need
>   a bailout – could be a trillion dollars –

Funds are already advanced to the homeowners which supports demand.

A ‘bailout’ would only be an accounting entry between the government’s account and the agency’s account – no effect on aggregate demand.

>   the USA may lose its AAA credit rating.

Like Japan did. Just another sign of incompetance by the ratings agency if it happens.

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Re: Sauding spending

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>
>   On Mon, Apr 21, 2008 at 9:23 AM, Scott wrote:
>
>   Backed by high oil prices, Saudi Arabia is embarking
>   on a massive spending program focused predominantly
>   on infrastructure projects. The value of announced
>   investment projects so far is $862 billion.
>

Thanks, looks like maybe they’ve figured it out as suspected (jack up price and spend the USD) which improves their real terms of trade while hurting ours and keeps US GDP higher to please policy makers who think it’s all a good thing.

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