Stanley Fischer: US confidence still lacking
THE AUSTRALIAN DECEMBER 04, 2014 12:00AM
Damon Kitney
Victorian Business Editor
Melbourne
(FILES)--A May 25, 2011 file photo of Stanley Fischer, Governor of the Bank of Israel listens as he listens to a speech duri...
Stanley Fischer, then governor of the Bank of Israel, at an OECD meeting in 2011. Source: AFP
WHEN he returned to live in the US this year after eight years running the Bank of Israel, Stanley Fischer had a surprising observation about corporate America.
“I have a slight sense that the animal spirits are not as they used to be,” the now vice-chairman of the US Federal Reserve told The Wall Street Journal’s CEO Council forum in Washington.
Despite the Fed holding interest rates near zero since 2008 and US growth now above 2 per cent and unemployment continuing to fall, Mr Fischer said the level of business investment was “not as high as you would have expected”.
He said it would take more time for society to trust business and the banks again after the disaster of the global financial crisis and noted productivity growth was still “way way down”.
His comments were backed by the latest quarterly survey findings of the Business Roundtable. It found CEOs from major US companies did not expect strong US economic growth in 2015.
Still, a snap poll of executives attending the CEO Council forum found that 77 per cent would focus their investment in the US next year. Only 13 per cent said China would be their biggest focus. In their eyes, Europe remains the biggest risk to the global economy in the year ahead.
With their focus fixed on home, Mr Fischer had an important message for the CEOs — including News Corp chairman Rupert Murdoch and CEO Robert Thompson — that assembled at Washington’s Four Seasons Hotel: the US was still “far from a normal situation”.
“We’ve almost got used to zero being the natural place for interest rates. It is far from it. We need to start thinking about what is going to happen in the year or years to come as we go back to a normal situation,” he said.
He said the first rate rise would be very important after the Fed in October ended its bond-purchase program. Economists expect US interest rates to start rising in the middle of next year.
“There is a process that is being set off when the first step starts — interest rates are going to go up and they are going to keep going up for some time, ” he said.
He said the Fed would continue to be driven “by the data”.
“We don’t want to surprise markets. On the other hand, we can’t give precise estimates about dates that we don’t know, and that’s why the emphasis always goes back to the data,” he said.
Fed report shows optimism about US economic outlook
Business | Updated today at 03:27 AM
WASHINGTON (AFP) - The US economy continued growing in October and November amid widespread optimism about the growth outlook, according to a Federal Reserve report released Wednesday.
The Fed's Beige Book on current economic conditions said that "a number" of the central bank's 12 districts reported contacts "remained optimistic about the outlook for future economic activity."
For the first time in more than a year, the Fed dropped its "modest" and moderate" descriptions of overall growth in the world's largest economy, saying simply that reports suggest "that national economic activity continued to expand" in the last two months.
But the details of the report were encouraging, with contacts in 11 of the districts described as "optimistic" about their sector and the economy's direction in general.
Notably absent from the upbeat category was the huge San Francisco Fed district, which includes California and eight other western states, where the economy was said to be "improving moderately."
Consumer spending, which accounts for about two-thirds of US output, "continued to advance" in most districts, said the report, which will inform discussions at the Federal Open Market Committee's last monetary policy meeting of the year, on Dec 16 and 17.
Employment gains, the primary object of the Fed's easy-money policy, were described as "widespread" while overall price and wage inflation remained "subdued."
U.S. CEOs say having hard time finding workers with right skills
WASHINGTON Wed Dec 3, 2014 3:32pm EST
(Reuters) - Most chief executive officers at U.S. corporations report significant problems in finding workers with the skills they need, according to a survey released on Wednesday.
Among rich countries, the United States is a relative laggard when it comes to educating its youth, especially in skills like math, which is seen as vital in an increasingly high-tech global economy.
Growth in U.S. college enrollment has also slowed since the 1980s, a factor many economists believe has led to rising income inequality because the demand for high-skill workers could be outstripping their supply.
Two business groups, Business Roundtable and Change the Equation, surveyed 126 companies and found 46 percent saw a skills shortage as a problem and 6 percent as very problematic. The rest saw a shortage only somewhat as a problem, or not one at all.
The survey found about two-fifths of the companies' job openings required advanced knowledge of science, technology, engineering and math.
(Reporting by Jason Lange; Editing by Meredith Mazzilli)
November jobs report puts Dow in sight of 18,000
SAUMYA VAISHAMPAYAN DOW JONES DECEMBER 06, 2014 10:49AM
Traders are eyeing 18,000 for the Dow as they work on the floor of the New York Stock Exchange. Source: AFP
THE Dow industrials and the S&P 500 pushed to record closes, capping their seventh week of gains, as investors cheered a strong jobs report that underscored the health of the US economy.
Providing stocks room to run was a sense among investors that the November jobs report wasn’t enough to push the Federal Reserve to raise interest rates sooner than expected.
With US inflation low and slowing economic growth abroad, most investors don’t expect the Fed to lift rates until the second half of 2015.
The Dow gained 58.69 points, or 0.3 per cent, to 17958.79. It rose within striking distance of 18,000 during the session. The S&P 500 added 3.45 points, or 0.2 per cent, to 2075.37. The Nasdaq Composite Index rose 11.32 points, or 0.2 per cent, to 4780.76.
The Dow has gained about 11 per cent since its Oct. 16 low of 16117.24, hitting several records in recent weeks.
The gains have been fuelled by third-quarter earnings that were viewed as broadly positive and improving US economic data. The US is on track to post its strongest year of job growth since 1999. Also helping to make stocks appear more attractive are easing efforts by major central banks, which will maintain pressure on already low global interest rates.
“The strong labour report, on the heels of the strong GDP numbers that we’ve seen lately in the US, is validating this robust economic environment,” said Joe Spinelli, head of Americas single-stock trading at Deutsche Bank. “That is increasing people’s conviction that the market should rally into year-end,” he said.
In 117 years, the Dow has gained during the month of December 84 times.
The Labor Department reported that non-farm payrolls rose 321,000 last month, the strongest month of hiring since January 2012. Economists surveyed by The Wall Street Journal expected the creation of 230,000 jobs in November. Payroll gains in September and October were revised higher to show that US employers added 44,000 more jobs than previously estimated.
The jobs report reinforced the case for stocks going higher, said Kate Warne, investment strategist at Edward Jones.
“More jobs mean more consumer spending,” she said. “That means better overall growth and earnings, which is good news for stocks.”
Stocks can continue to gain even when the Fed begins to raise short-term interest rates, according to Bernie Williams, chief investment officer of USAA Investment Solutions, which oversees about $22 billion.
A “1 per cent fed funds rate isn’t going to kill” the rally, he said. “Even if we’re raising rates, we’re still in a situation where Europe is about to undergo [quantitative easing] ... so the world is still very stimulative,” he added.
Financial stocks rose the most on the S&P 500, pushing the sector up 1 per cent. J.P. Morgan Chase & Co. and Goldman Sachs Group Inc led the Dow higher. Stocks in the utilities sector, which are often viewed as proxies for bonds, fell 0.8 per cent.
David Chalupnik, head of equities for Nuveen Asset Management, said he has been adding to positions in sectors that would benefit from improving US economic growth and lower oil prices.
“We have been adding to our consumer discretionary holdings and our holdings of industrials that primarily operate here in the US,” he said. In the consumer discretionary sector, he said he bought companies involved in recreational products, such as boats and motorcycles. He also has bought or added to positions in industrial companies tied to the trucking sector, which could see an uptick in activity and benefit from lower oil prices.
The dollar jumped to fresh highs against the euro and the yen after the jobs report, highlighting traders’ expectations that the Fed will raise short-term interest rates in 2015, even as the Bank of Japan is ramping up its easing steps and the European Central Bank is expected to soon take its own new stimulus measures.
Bets that the Fed will raise rates at its Sept. 2015 policy meeting rose to 72 per cent in the wake of the strong November jobs report, from 56.9 per cent Thursday, based on pricing for federal funds rate futures from the CME Group. Odds for a June move rose to 32 per cent from 22.3 per cent.
Bond prices fell as the affirmation of steady economic growth in the US sapped investors’ appetite for safe-haven US Treasurys. The benchmark 10-year note yield rose to 2.306 per cent. When bond yields rise, prices fall.
“If we have two or three more strong jobs reports like this, it increases the chance that the Fed would raise interest rates sooner than many have thought,” said Gary Pollack, who helps oversee $12 billion as head of fixed-income trading in New York at Deutsche Bank AG’s private wealth management unit.
Gold, another traditional safe haven, also declined. Gold futures declined 1.4 per cent to $1,190.10 an ounce. Crude-oil futures fell 1.5 per cent to $65.84 a barrel. Energy stocks on the S&P 500 fell 1.2 per cent. Stocks rose in Europe, with the Stoxx Europe 600 index up 1.8 per cent.
In corporate news, Dollar Tree Inc said its pending $8.5 billion acquisition of Family Dollar Stores Inc could close as early as February. Dollar Tree said it would have to shed a small number of stores for antitrust approval of the deal.
Shares of Dollar Tree fell 1.2 per cent, while those of Family Dollar inched up 0.1 per cent. Shares of Google Inc fell 2.7 per cent. Bank of America Merrill Lynch cut the company to a neutral rating from buy.
Housing starts ‘sign of spring rebirth’
JOSH MITCHELL AND KRIS HUDSON THE WALL STREET JOURNAL JANUARY 23, 2015 12:00AM
A BURST of groundbreakings for single-family homes last month offered hope a key part of the US housing market is revving up after years of malaise.
Housing starts rose 4.4 per cent in December from a month earlier to an annual rate of 1.089 million, the Commerce Department said. Starts on single-family homes, which exclude apartments and reflect the bulk of the market, rose to a rate of 728,000, the highest level since March 2008.
Building permits for single-family homes climbed 4.5 per cent, the biggest increase since September 2012. Permits for all private housing, however, fell 1.9 per cent to an annual rate of 1.032 million amid a decline in demand for apartments.
December traditionally brings a small volume of construction starts, since most home builders are focused that month on closing home sales before the end of the year. However, an uptick in December starts sometimes can mean builders are gearing up in anticipation of a robust spring selling season.
“With mortgage rates remaining ultra-low, the housing market is in decent shape although it continues to run at relatively low levels compared to the years covering the housing boom,” analyst Andrew Wilkinson said in a note to clients.
Economists surveyed by The Wall Street Journal had expected overall housing starts to reach a rate of 1.04 million last month and building permits to hit a pace of 1.06 million.
Housing starts peaked at a rate of 2.27 million in January 2006 before crashing below 500,000 in the depths of the recession.
Home construction is still weak historically more than five years after the recession. The sluggishness has been puzzling given that interest rates have fallen quickly in recent months and job growth surged last year.
The average rate on a 30-year fixed mortgage fell to 3.66 per cent last week, the lowest level since spring 2013, according to Freddie Mac.
U.S. Stocks Plunge Nearly Three Hundred Points
(Bloomberg) -- U.S. stocks tumbled, with the Nasdaq 100 Index falling the most since April, as a drop in durable-goods orders and disappointing results from Caterpillar Inc. to Microsoft Corp. heightened concern about the economy’s strength.
Technology shares in the Standard & Poor’s 500 Index plunged 3.3 percent for the biggest drop since November 2011. Microsoft lost 9.3 percent, the most in 18 months, as software-license sales to businesses were below forecasts. Caterpillar plunged 7.2 percent after forecasting 2015 results that trailed estimates as plunging oil prices signal lower demand from energy companies. Procter & Gamble Co. slid 3.5 percent as a surging U.S. dollar cut into its earnings.
Apple Inc. jumped more than 6 percent in after-market trading after reporting revenue that topped estimates. Yahoo! Inc. surged 6 percent in late trading after announcing a tax-free spinoff of its stake in Alibaba Group Holding Ltd.
“Currency headwinds, as well as evidence of a continual deceleration of global growth, is having a major impacts on quarterly results,” Chad Morganlander, a money manager at St. Louis-based Stifel, Nicolaus & Co., which oversees about $160 billion, said in a phone interview. “Coupled with that, durable goods orders were somewhat disappointing, which scotches any optimism for today’s trading session.”
The Standard & Poor’s 500 Index slipped 1.3 percent to 2,029.55 at 4 p.m. in New York, below its average price for the past 50 days. The Dow Jones Industrial Average declined 291.49 points, or 1.7 percent, to 17,387.21, after losing almost 400 points earlier in the day. The Nasdaq 100 Index tumbled 2.6 percent for the biggest drop since April.
Read more here
Seems like the effect of ending the QE program is finally starting to show on the US economy, next will be job figures getting worse and they will blame it on the snowstorms.... time to profit take and load up the elephant gun...
Do you think the new "nonprime" bonds is less risky than the previous subprime bonds? The previous mistake isn't on the product, but perceived as less risky by various re-packaging...
Subprime bonds back with different name seven years after US crisis
NEW YORK (Jan 28): The business of bundling riskier US mortgages into bonds without government backing is gearing up for a comeback. Just don’t call it subprime.
Hedge fund Seer Capital Management, money manager Angel Oak Capital and Sydney-based bank Macquarie Group are among firms buying up loans to borrowers who can’t qualify for conventional mortgages because of issues such as low credit scores, foreclosures or hard-to-document income.
They each plan to pool the mortgages into securities of varying risk and sell some to investors this year.
JPMorgan Chase analysts predict as much as US$5 billion of deals could get done, while Nomura Holdings forecasts US$1 billion to US$2 billion.
Investment firms are looking to revive the market without repeating the mistakes that fuelled the US housing crisis last decade and blew up the global economy.
This time, they will retain the riskiest stakes in the deals, unlike how Wall Street banks and other issuers shifted most of the dangers before the crisis.
Seer Capital and Angel Oak prefer the term “nonprime” for lending that flirts with practices that used to be employed for debt known as subprime or Alt-A.
...
http://www.theedgemarkets.com/sg/article...-us-crisis
Yellen's global conundrum
1671 words
14 Mar 2015
The Australian Financial Review
AFNR
English
Copyright 2015. Fairfax Media Management Pty Limited.
Monetary policy The Fed chair confronts a tricky task: how to raise US interest rates while the dollar surges without tipping the world into chaos, write John Kehoe and Mark Mulligan.
So long has it been since interest rates were lifted in the United States - an incredible nearly nine years - that one senior market player meeting the AFR Weekend in New York this week observed that many bank, investment and hedge fund professionals had never experienced a rate rise. And nobody can ever remember US rates taking off from zero.
It's one of the unknown factors that makes the chief task ahead for Janet Yellen and the US Federal Reserve board so tricky: how to raise rates in the world's largest economy without unleashing too much chaos across currency, equity, commodity and credit markets. And now a fresh complication is making the task even more difficult: the US dollar is surging against the world's currencies, denting the earnings of US multinationals, causing sharemarkets from New York to Sydney to gyrate wildly, weighing down commodity prices and threatening a rush of money out of emerging economies.
When things get moving in the US - like the hottest jobs market since the late 1990s - the rest of the world feels it. And they feel nothing more immediately than the US dollar. The greenback is the world's reserve currency. Prices of commodities such as oil and Australia's key export, iron ore, are priced in US dollars. This week the greenback touched a 12-year high against the euro and the Australian dollar fell on Wednesday to US75.61¢, its lowest since May 2009.
Adjusted for inflation, the US dollar has soared 30 per cent from its low in 2011 compared with the currencies of major trading partners. It is marching higher in anticipation the Fed will start lifting rates from near zero in coming months - as early as June. But the dollar's surge before a rate rise has a series of major consequences - some good and some not so good - for the world economy. Like moving around on a water bed, everything else is getting bounced around.
Barry Bosworth, who has the chair in international economics at the Brookings Institution in Washington DC, says the stronger greenback is a reflection of the US economic recovery and other central banks loosening monetary policy.
"The price of the [US] dollar can be expected to rise even further in relative terms," Bosworth says. That will provide even more of a "blessing" for American consumers, he says, as their purchasing power is boosted.
It has another less welcome implication for the US, however.
The Fed is looking for proof that America's economic recovery is firm underfoot before it takes interest rates higher, but a stronger dollar is a headwind for US economic growth as exports become less competitive and imports cheaper.
US multinational companies including Caterpillar, Microsoft and Procter & Gamble have cautioned that their earnings will be hurt by the strong currency. S&P 500-listed firms in the US earn about 45 per cent of their revenues abroad. So when they repatriate the offshore sales in a rising currency environment, US dollar earnings are lower.
A Duke University survey of more than a thousand US chief financial officers published this week shows they are worried about falling victim to currency wars.
The European Central Bank has joined Japan in fighting disinflation by embarking on a huge stimulus program to drive down long-term interest rates. Denmark, Sweden and Switzerland have resorted to negative rates. Currencies are consequently plummeting against the US dollar. "US exporters are being punished by these competitive depreciations and this will lead to lower profits and less employment," Duke business school professor Campbell Harvey says.
So while money is flooding into the US and pushing up the greenback because markets are anticipating higher rates, that flood of money could paradoxically push out the date the Fed starts to lift rates.
A second major implication is being felt in emerging economies with large external debts in the US currency, such as Brazil, Russia, South Africa and Turkey. Emerging markets are well versed in the chaos that can be unleashed by the prospect of higher US rates, having experienced it in 2013.
Referred to as the "taper tantrum", the episode was triggered by the Fed chairman, then Ben Bernanke, flagging plans eventually to taper off its $US4 trillion quantitative easing program and move towards monetary tightening. Asset prices and currencies tumbled from Brazil to South Africa and Turkey as developing economies succumbed to capital flight.
Market volatility persisted into early 2014, making investors fussier about which emerging markets were worth the risk. Since then, picking winners has been complicated by tanking commodity prices and a turbo-charged greenback.
"We think there are some selective emerging market opportunities," says Michael Hasenstab, an emerging-market bond specialist at Franklin Templeton Investments. "However, it's not uniform like it was in 2009, when you'd almost buy any emerging market asset and over the next three years you'd make money."
At the basket-case end of this spectrum are countries such as Venezuela and Nigeria, which rely on oil for virtually all their export income and are living hand to mouth.
Russia, too, is suffering - from the twin blows of lower oil prices and economic sanctions. The US dollar's rally has only exacerbated capital flight from Moscow, helping drive the rouble down an astonishing 67 per cent against the greenback since July.
At the other extreme is Mexico, a country whose fortunes have long tracked those of its much richer northern neighbour, thanks to tight trade links and migrant remittances.
This time around, and unlike the notorious tequila crisis of 1994-95, the US dollar-denominated debt exposure of the public and private sectors in Mexico seems manageable. Indeed, the currency's 20 per cent fall against the US dollar since July is considered a boon to exporters.
And although investors and analysts look at emerging markets case by case, most agree they all have something in common that should preclude any repeat of the contagious financial meltdowns of past decades.
"One thing we've been quick to point out: in contrast to previous leverage cycles in the emerging markets, this one has actually been disproportionately financed in local debt," says Joseph Lupton, senior global economist at JP Morgan. "This is not to say there is no US dollar-denominated debt in these countries, but the exposure risk is not the same as in the past."
This does not allow countries such as Brazil off the hook, however. As well as being battered by lower commodity prices, South America's erstwhile poster child for emerging market growth and development is about to pay for years of fiscal prime-pumping, generous tax breaks, welfare increases and infrastructure spending with a period of stagflation, say analysts. The collapse of Brazil's currency, the real, against the greenback is a double-edged sword.
"Exporters will benefit from the cheaper real, but set against that, many businesses have borrowed in dollars and will see the cost of debt service rise," says Richard Lapper, principal of the Financial Times' Latin Confidential reports. "Some of these dynamics will get worse when the Fed starts to increase US rates."
Another challenge for Brazil is the third major effect of the dollar's rise: commodity prices quoted in US dollars tend to fall whenever the greenback strengthens. The reason is demand and supply: a jump in the US dollar means a Russian oil producer, say, now receives more for their product in rouble terms and so is prepared to pump and sell more. Its European customer, however, is less prepared to buy the oil as it now costs them more euros to buy the same amount. When higher supply meets lower demand, the US dollar prices fall to clear the market mismatch.
So from Brazil, to Moscow, to the Reserve Bank of Australia, which has been hoping for a weaker Australian dollar to jumpstart the local economy, Fed watchers will be paying close attention to Yellen next week.
The Fed's two-day policy meeting wrapping up on Wednesday will decide whether to ditch the pledge to be "patient" before raising rates. Such a move would make a rate rise in June a live option. Bond markets are pricing in a less than one-in-three chance of lift-off then. But they may be underestimating the Fed's preference to normalise extreme monetary policy sooner rather than later. Wells Fargo Securities chief economist John Silvia says: "We expect a removal of the word 'patient' in March and a June increase in the Fed funds rate, which should provide a signal to private agents upon which to make thoughtful decisions."
Wall Street is largely ignoring such warnings. The 1.3 per cent rally in the S&P 500 on Thursday to recoup steep losses earlier in the week was predicated on the release of weak retail sales data. Traders bet, perhaps wishfully, that the Fed would defer raising rates. Fed doves may also be overstating the negative impacts of a strong $US.
The US economy is also relatively closed, with exports accounting for just 13 per cent of gross domestic product - far lower than most economies.
Erik Weisman, a portfolio manager at MFS Investment Management, says the dollar is rebounding from very low levels. So the 15 per cent rise on a trade-weighted basis since the middle of last year is a natural rebalancing.
"We would need to see a very sharp and powerful move in the [US] dollar for the Fed to be concerned," he says. "It's going to depend upon how much more the dollar appreciates."
WITH ADDITIONAL REPORTING BY PATRICK COMMINS
US Federal Reserve faces obstacles on its interest rate path
BUSINESS SPECTATOR MARCH 16, 2015 1:17PM
Stephen Bartholomeusz
Business Spectator Columnist
Melbourne
WHEN the Federal Reserve board’s open market committee meets later this week, it could mark another of those significant milestones on the path towards normalisation of US monetary policy settings. It might also ignite another bout of turmoil in global currency and bond markets.
The Fed isn’t going to announce the first rise in US official interest rates for nearly a decade after this week’s meeting. The most bullish expectation is that it might change the language associated with its perceived path towards that moment.
Where the Fed has been saying it would be “patient” in beginning to normalise its monetary policy stance, there is an expectation that it will drop “patient” from its lexicon, signalling that the start of the new phase in US monetary policy is nearing. The market believes that the first increase in US rates could occur in June.
The combination of the expectation that US monetary policy settings will start to be unwound this year and the quantitative easing policies of Japan (and more recently, the eurozone) have added a new layer of complication to the Fed’s deliberations.
The US dollar has been surging, nearing parity with the euro, and impacting the competitiveness of US exporters. The US dollar has risen 16 per cent against the euro in the past three months and about 25 per cent over the past year.
The combination of the stronger dollar and the collapse in the oil price means inflation isn’t a near-term issue for the Fed. It will have to weigh the impact on US competitiveness against the boost to consumers provided by the stronger dollar and the lower oil prices.
The speculation about the Fed’s intent has added to the volatility in currency and other financial markets generated by the quantitative easing and looser monetary policies adopted by much of the rest of the world.
More than 20 countries have cut their official interest rates over the past year, some to negative levels, to try to offset the impact of the competitive devaluations driven by quantitative easing in Japan and Europe.
When coupled with the rising US dollar, that has added to the volatility in capital flows and currencies. Last week, for instance, the Australian dollar fluctuated between a high of US77.40c and a low of US75.61c.
If the Fed signals a rate rise is looming in the next few months, one would expect the pressure on the Australian dollar to intensify.
The Reserve Bank’s desire for a lower dollar — something around or below US75c — is increasingly likely to be met, and probably overshot. With most of our major trading partners pursuing low interest rate and weaker currency strategies, depreciation against the US dollar doesn’t necessarily rule out further RBA cuts to a cash rate that is already at a historic low.
The expectations around US monetary policy are self-fuelling, attracting flows of capital into the US that keep US market interest rates low despite the likelihood of rising official rates and which push up the US dollar and other currencies down. Capital is flowing out of developing economies towards the US, which could create some unforeseen shocks.
The divergence between US and eurozone settings is transforming the euro into the new currency for carry trades and hot money, while helping to generate some much-needed positive impacts on the region’s competitiveness and activity levels. The normalisation of US settings might be within sight; those of the eurozone, however, are likely to remain unconventional for a long time yet.
Even if the Fed does provide a signal that normalisation of monetary policy will begin shortly, no one expects the path of that process to be rapid.
It will probably take several years or more, with lots of pauses in the process to take stock not just of the health of the underlying real economy, but of the policy settings of the rest of the developed world. The strength of the dollar in the face of the competitive devaluations occurring elsewhere may be a major input to policy.
The divergence already occurring between the US settings and those of the other key developed economies — which would be exacerbated if the Fed does start raising rates — adds uncertainty to an already uncertain environment. It probably ensures that the volatility in capital flows and financial markets that has been a major feature of the post-financial crisis environment will remain a constant for quite some time yet.
Business Spectator
Fed’s bid for flexibility on rates sets stage for market volatility
JON HILSENRATH THE WALL STREET JOURNAL MARCH 18, 2015 4:13PM
AFTER years of reassuring the public that interest rates would stay low, the Federal Reserve is about to create some uncertainty by veering away from such promises.
The US central bank has provided strong verbal guidance about the likely level and direction of short-term rates for more than a decade, making it a key policy tool for influencing other borrowing costs in the economy. Such signals have been particularly important since December 2008, when officials began promising to hold their benchmark short-term rate near zero for a long time.
Ahead of their current policy meeting, Fed officials signalled they wanted to drop the latest iteration of such guidance — a line in their policy statement pledging to be “patient” before deciding to raise rates.
In addition to signalling that the Fed expects to consider raising rates later this year, the move is part of the central bank’s broader effort to avoid pinning itself down. Fed officials themselves are uncertain about when to start the process of raising rates and want flexibility to respond to new information about how the economy is evolving.
The move could be a test for investors. In theory, less-clear-cut interest-rate guidance from the Fed should lead to more volatility in financial markets. That’s because investors will be left less certain about a key variable in every asset-valuation model — the cost of funds.
Yet measures of market volatility are sending divergent signals.
Stock market volatility is relatively subdued. The Chicago Board Option Exchange’s stock volatility index, for example, has averaged 17 this year, above last year’s 14 but below its average of 21 between 2009 and 2014. The higher the measure, known as the VIX, the more volatility.
Moreover, yields on 10-year Treasury notes have been confined between 1.6 per cent and 2.3 per cent since late last year.
At the same time, however, measures of short-term interest rate and currency volatility have picked up. Merrill Lynch’s MOVE index, which tracks expected interest rate volatility, has risen to levels last seen in the summer of 2013, when Fed signals about the coming end of a bond-purchase program led to a “taper tantrum” that unsettled markets globally.
Torsten Slok, chief international economist at Deutsche Bank Securities, said this rate volatility portends broader turbulence.
“The risk here is that when volatility goes up in rates it will be spilling over into other asset classes,” he said.
Such turmoil could affect other borrowing costs for US households and businesses, such as rates on mortgages, credit cards and corporate bonds. It could also hit their stock portfolios and 401(k) saving accounts.
The Fed has been experimenting with interest-rate guidance since 2003, when then-Chairman Alan Greenspan offered an assurance to investors that short-term rates — then 1 per cent — would remain low for a “considerable period.” Then when the Fed started raising rates in 2004, it kept reassuring investors it would move them up at a “measured pace.” It proceeded to raise its benchmark short-term rate by a quarter percentage point at 17 straight meetings.
The goal initially was to offer a promise of low rates to hold down long-term rates. Inflation was low and the economy producing jobs slowly and the Fed wanted to keep credit easy. Then during the rate increases in 2004, the Fed wanted to tamp down the market’s reaction. Mr Greenspan had seen how many investors were caught off guard by rate increases in 1994.
Mr Greenspan’s successor as Fed chairman, Ben Bernanke, at times moved more aggressively than expected with short-term rate cuts in 2008. He then adopted assurances they would stay low. He hoped they would hold down long-term interest rates to provide an added boost to a damaged economy deeply in need of stimulus. The Fed also wanted to be more transparent about its thinking.
As the economy improves, Fed officials hope, the boost from low rate promises becomes less necessary. Moreover, officials see a fine line between transparency and tying their hands.
Many officials believe the Fed’s “measured pace” guidance during 2004 to 2006 was a mistake, by making their actions too predictable.
Fed officials now believe the central bank needs to be able to alter its pace of rate changes as the economy evolves.
“We’d probably not like to repeat a sequence in which there was a measured pace and [quarter-percentage-point] moves at every meeting,” Fed Chairwoman Janet Yellen said in a December press conference. “I certainly don’t want to encourage you to think that there will be a repeat of that.”
They have other misgivings about the guidance they’ve given in the past. One is an appearance that they are tied to specific dates for action.
“There is no good reason that I can see for us to have to telegraph every action that we need to take,” Fed Vice Chairman Stanley Fischer said in February.
Still, in practice moving toward vaguer guidance about interest rates could be a challenge for the Fed. Even when officials have tried to move away from telegraphing their actions in the past, they have found themselves drawn back to behaving in highly predictable ways.
In winding down the bond-buying program known as quantitative easing in 2014, for example, the Fed said the pace of its actions would depend on the performance of the economy. Economic output varied sharply in 2014 — contracting in the first quarter and then expanding at an annual rate near 5 per cent in the middle of the year — but the Fed reduced its monthly bond purchases in steady increments.
In December, some Fed officials wanted to eliminate rate guidance altogether. Instead, the central bank adopted the “patient” approach, expecting to get rid of it soon. Ms Yellen said in December the term meant the Fed was unlikely to raise rates at its subsequent two meetings.
If the phrase appeared in the statement tomorrow morning (AEDT), it would rule out a rate increase at the next meetings in April and June. It is likely to be dropped because several officials have said they want to consider a June rate rise.
Jeremy Stein, a Harvard University economics professor and former Fed governor, sees a conundrum brewing for officials. Even if the central bank says its actions will be less predictable, the market will infer a rate path from its actions. To avoid unsettling markets, he said, Fed officials have an incentive to stick to the path investors infer.
“It is a hard thing to manage. You almost have to psyche yourself up to not worry too much about spooking the bond market,” he said.
Donald Kohn, a Brookings Institution fellow and the Fed’s former vice chairman, noted that investors will still be getting plenty of clues from the Fed about the outlook, even after dropping the patience pledge.
Fed officials’ quarterly economic forecasts include projections of interest rates in the future. Though not the official policy, these forecasts are an indication of what Fed officials themselves expect.
Meantime, the Fed’s policy statement contains other hints that aren’t going away, including yet another reassurance that rates will remain below their longer-run averages “for some time.”
“We’re not moving to a regime which is totally devoid of guidance,” Mr Kohn said.
Wall Street Journal