Day: September 17, 2014

Redacted Version of the September 2014 FOMC Statement

Redacted Version of the September 2014 FOMC Statement

Photo Credit: DonkeyHotey
Photo Credit: DonkeyHotey
July 2014 September 2014 Comments
Information received since the Federal Open Market Committee met in June indicates that growth in economic activity rebounded in the second quarter. Information received since the Federal Open Market Committee met in July suggests that economic activity is expanding at a moderate pace. This is another overestimate by the FOMC.
Labor market conditions improved, with the unemployment rate declining further. However, a range of labor market indicators suggests that there remains significant underutilization of labor resources. On balance, labor market conditions improved somewhat further; however, the unemployment rate is little changed and a range of labor market indicators suggests that there remains significant underutilization of labor resources. More people working some amount of time, but many discouraged workers, part-time workers, lower paid positions, etc.
Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. No change

 

Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. Fiscal policy is restraining economic growth, although the extent of restraint is diminishing. No change.? Funny that they don?t call their tapering a ?restraint.?
Inflation has moved somewhat closer to the Committee’s longer-run objective. Longer-term inflation expectations have remained stable. Inflation has been running below the Committee’s longer-run objective. Longer-term inflation expectations have remained stable. TIPS are showing slightly lower inflation expectations since the last meeting. 5y forward 5y inflation implied from TIPS is near 2.52%, down 0.08% from July.
Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. No change. Any time they mention the ?statutory mandate,? it is to excuse bad policy.
The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. No change.? They can?t truly affect the labor markets in any effective way.
The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced and judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year. CPI is at 1.7% now, yoy.? They shade up their view down on inflation?s amount and persistence.
The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. The Committee currently judges that there is sufficient underlying strength in the broader economy to support ongoing improvement in labor market conditions. No change.
In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in August, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $10 billion per month rather than $15 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $15 billion per month rather than $20 billion per month. In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions since the inception of the current asset purchase program, the Committee decided to make a further measured reduction in the pace of its asset purchases. Beginning in October, the Committee will add to its holdings of agency mortgage-backed securities at a pace of $5 billion per month rather than $10 billion per month, and will add to its holdings of longer-term Treasury securities at a pace of $10 billion per month rather than $15 billion per month. Reduces the purchase rate by $5 billion each on Treasuries and MBS.? No big deal.

 

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. No change
The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. The Committee’s sizable and still-increasing holdings of longer-term securities should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative, which in turn should promote a stronger economic recovery and help to ensure that inflation, over time, is at the rate most consistent with the Committee’s dual mandate. No change.? But it has almost no impact on interest rates on the long end, which are rallying into a weakening global economy.
The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. The Committee will closely monitor incoming information on economic and financial developments in coming months and will continue its purchases of Treasury and agency mortgage-backed securities, and employ its other policy tools as appropriate, until the outlook for the labor market has improved substantially in a context of price stability. No change. Useless paragraph.
If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings. If incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will end its current program of asset purchases at its next meeting. Finally the end of QE is in sight.? For now.
However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. However, asset purchases are not on a preset course, and the Committee’s decisions about their pace will remain contingent on the Committee’s outlook for the labor market and inflation as well as its assessment of the likely efficacy and costs of such purchases. No change.
To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that a highly accommodative stance of monetary policy remains appropriate. No change.
In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. No change.? Monetary policy is like jazz; we make it up as we go.? Also note that progress can be expected progress ? presumably that means looking at the change in forward expectations for inflation, etc.
The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. No change.? Its standards for raising Fed funds are arbitrary.
When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. No change.
The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run. No change.
Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo. Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Narayana Kocherlakota; Loretta J. Mester; Jerome H. Powell; and Daniel K. Tarullo. Fisher and Plosser dissent.? Finally some with a little courage.
Voting against was Charles I. Plosser who objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends,” because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals. Voting against the action were Richard W. Fisher and Charles I. Plosser. President Fisher believed that the continued strengthening of the real economy, improved outlook for labor utilization and for general price stability, and continued signs of financial market excess, will likely warrant an earlier reduction in monetary accommodation than is suggested by the Committee’s stated forward guidance. President Plosser objected to the guidance indicating that it likely will be appropriate to maintain the current target range for the federal funds rate for “a considerable time after the asset purchase program ends,” because such language is time dependent and does not reflect the considerable economic progress that has been made toward the Committee’s goals. Thank you, Messrs. Plosser and Fisher.? But what happens when the economy weakens?

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Comments

  • Pretty much a nothing-burger. Few significant changes, if any.
  • Despite lower unemployment levels, labor market conditions are still pretty punk. Much of the unemployment rate improvement comes more from discouraged workers, and part-time workers.? Wage growth is weak also.
  • Small $10 B/month taper. Equities rise and long bonds fall.? Commodity prices are flat.? The FOMC says that any future change to policy is contingent on almost everything.
  • Don?t know they keep an optimistic view of GDP growth, especially amid falling monetary velocity.
  • The FOMC needs to chop the ?dead wood? out of its statement. Brief communication is clear communication.? If a sentence doesn?t change often, remove it.
  • In the past I have said, ?When [holding down longer-term rates on the highest-quality debt] doesn?t work, what will they do? I have to imagine that they are wondering whether QE works at all, given the recent rise and fall in long rates.? The Fed is playing with forces bigger than themselves, and it isn?t dawning on them yet.
  • The key variables on Fed Policy are capacity utilization, labor market indicators, inflation trends, and inflation expectations. As a result, the FOMC ain?t moving rates up, absent improvement in labor market indicators, much higher inflation, or a US Dollar crisis.
Making Systematic Risk Disappear, Not

Making Systematic Risk Disappear, Not

Photo Credit: B Gilmour
Photo Credit: B Gilmour

Yesterday I was at a conference for Registered Investment Advisors. There were about 11 of us in the room, and a variety of different parties pitched us on their services. Some of the pitches were harder, most were softer.

Two of the presentations I felt were deceptive, though I don’t believe the presenters intended to be deceptive. The idea was, you need to provide alternative investments to your clients, because clients can’t earn what they need to in stocks and bonds. Private equity investments and real estate outperform stocks, and we have new durable income vehicles that outperform bonds. What’s more, we can remove a lot of volatility from the portfolio.

Imagine for a moment that you’re investing in two private companies that after you buy them, you will have to own them for 10 years. The money is committed, and you have no way to get liquidity from the companies until the 10 years are up. One of the companies will leverage up a little bit, and invest in stocks. The other company will leverage up a great deal, and invest in bonds; it will behave like a shadow bank.

Now imagine on your brokerage statement, that your broker does not have to mark the positions to market. ?After all, the corporations are not publicly traded and so the companies are valued at the amount of your investment until they dissolve and pay out their proceeds at the end of 10 years.

Does this method of investing limit volatility? It looks like it does, but it really doesn’t. Your investments are subject to all of the vicissitudes of the stock and bond markets, and then some, because the private companies took on some leverage. Though the values may be constant on the accounting statements, the volatility of the investing will be delivered in full at the end of the 10 years.

That’s the way some of these alternatives work, except they get applied not to public stocks and bonds, but private companies, real estate, mortgages, etc. ?They are subject to the same economic forces as the public stocks and bonds, and once you strip out the effect of the additional leverage they perform about the same.

The story was told that this is the way that the wealthy got wealthy, by investing in private corporations, and investing in real estate. This is true as far as it goes except that the wealthy concentrated their investments in a few real estate projects and a few corporations that they themselves actively managed. Those offering alternative products investing in private equity and real estate are investing far more broadly in order to reduce risk. Even if the investments do well, you won’t get wealthy off them, though you might do well.

What is also not mentioned is that many more people who try to become wealthy by concentrating their investments fail. If this were easy, everyone would be doing it. The volatility is not eliminated; far from it, the volatility is amplified, and for those wealthy that succeed, that was the road to wealth for them.

As with public equity and bond investments, you will find that there are talented managers who can outperform the rest. Many of the talented managers in private investments limit the amount they manage, and money from new investors is not welcome. ?The best managers of alternative investments are not open to the public, and not to these private investment middlemen as the conference.

The same logic applies to hedge funds. There are many different types of hedge funds, and performance data for them is dirty. Some managers are good, some are bad, and on average they’re about as good as markets they invest in. As for some of the data abnormalities, the good ones get into the databases before they’re actually taking money from outside clients which overstates the returns to clients. The bad ones exit the databases early, so the returns on their failure do not get reported.

Though some notable managers will do well, average managers will not outperform investments in public stocks and bonds. This is another case where the actual underlying investments matter more than the legal form that the investments take. Private and public investments exist in the same economy and get roughly the same returns. This should be no surprise.

The upshot of what I’m trying to say is that if you are not investing in alternatives, don’t feel bad because you’re not missing anything on average. Just beware slick marketing pitches designed to make you feel inferior because you’re not one of the “cool kids” investing in illiquid private securities. ?After the next bear market, many “cool kids” will find that they lost a lot of money along with everyone else, if their alternatives mature in the bear market.

A Final Note — Fixed Income or Banking Income?

I also believe that income investors in?some of these new approaches will be the most disappointed in the next bear market. When I was a portfolio manager managing mortgage bonds, we had a rule: don’t buy mortgages on operating properties like hotels, marinas, casinos, theaters, etc. When you do that, you cease to be a lender, because the underlying cash flows of the property are not stable enough to support a loan. If you do such a loan, you have a smaller loan that is real, and the rest is an equity investment. ?In a bear market, that “equity investment” could prove worthless.

People will find out this same thing with durable income products, they will prove far more risky than ordinary fixed income investments in the next bear market because they are running a levered lending business. And in the few cases where the business is not levered, the riskiness of the investments is higher than what?would commonly expect.

And thus my counsel is focus on the return of your money, rather than the return on your money. Play it safe with your fixed-income investments.

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