Category: Monetary Policy

Reconciling the Fed’s Large Change in Forward Guidance

If there was one word Yellen emphasized yesterday it was caution.  The dot plot reflected that as well.  Can one ask if the Fed is being too cautious?  

Yellen acknowledged that the Fed’s assessment of the US economy had not changed much from December.  There is little reason it should.  However, it is difficult to reconcile that with the substantial change in the forward guidance, and the halving of the rates hikes that are deemed appropriate this year.

Monetary Policy’s Strange New World

There’s an old adage in economics that the best way to cure deflation is to drop money from helicopters. Clearly, this phrase isn’t older than mid-20th century, because before that time we didn’t have helicopters… we also didn’t have manipulative central banks. Now we have both, and they are about to join forces.

The helicopter statement isn’t meant literally. It conveys how central banks approach an economy when mainstream – and even out of the mainstream – monetary policies have failed.

A Rate Hike Today would be an FOMC Surprise

Since the Federal Reserve hiked rates in December, both the European Central Bank and the Bank of Japan have eased policy further.  The idea that because they cut rates means that the Fed cannot raise rates is a not a particularly helpful way to think about that is happening. 

The FOMC Meets and the ECB Moves Linger

The market’s focus has shifted to the two-day FOMC meeting that begins today.  The Federal Reserve should be pleased with recent developments.  Labor market slack continues to be absorbed.  Core inflation measures continue to edge higher. 

Interest Rate Policy vs. Monetary Policy

The market reaction to Draghi’s indication, once again, that interest rate policy has run its course, will be debated for some time.  Draghi delivered the goods that many investors said was lacking last December.  The ECB policy was more than anyone expected. 

All the boxes were checked.  Although the end date was not extended beyond March 2017, the four-year TLTROS will run into the new decade, and Draghi indicated that rates would remain low well beyond the end of the asset purchases.  Moreover, the deadline was always soft. 

Understanding the Point of the ECB’s Actions

The euro is paring the recovery that began in the middle of the ECB’s press conference yesterday. The market reaction was one intuitively expected to broad easing of interest rates and credit conditions. 

The market reversed, and violently so, only after Draghi seemed to rule out further interest rate cuts.  Many investors took this to mean the ECB had gone all in and that monetary policy had reached the end.   We do not expect this interpretation to be sustained. 

Seeking and Getting Approvals, Draghi and the ECB Move Ahead

Draghi delivered.  He managed to get approval for everything.  Rate cuts, acceleration of purchases, including corporate bonds to the purchase program and new long-term repos were announced.   The knee-jerk reaction was favorable.  The euro fell over 1% and peripheral European bonds rallied. 

Wrap Up: Fed and RBA Central Bank Minutes

The RBA minutes were not what I would call a riveting read. It almost verbatim confirms what was announced in the statement of monetary policy.

Last month’s the unemployment rate dropped (although January’s monthly figures show a surprise bump, for some reasons I will discuss further below) and the labour market is looking OK; housing price growth has slowed in Sydney and Melbourne easing concerns about a bubble, and inflation remains subdued. Essentially, no need to cut rates right now, but there seems to be some wiggle room if a cut is needed in coming months.

From Negative Rates to Positive Growth?

The Bank of Japan (BoJ) started quantitative and qualitative monetary easing (QQE) in 2013, committing to achieve 2 percent inflation in two years. Since then, almost three years have passed. However, the target has not been achieved, and it is uncertain when it will be. This is why the BoJ has taken the bold step into the realm of negative interest rates.

So, why did the inflation rate fail to rise as initially expected?

Outnumbered by Unorthodox Monetary Policies

In response to the global crisis, central banks have adopted unorthodox policies.  They expanded their balance sheets and broken the zero bound of interest rates.  Many investors have been critical of the central bank action on principle, but what has changed recently is that market developments have provided fodder for the ineffectiveness in practice.