I’ve been puzzling about the recent Fed actions, and I think there is less there than meets the eye.? Don’t get me wrong, the Fed has acted.? It is changing the composition of its balance sheet in the short run, absorbing MBS, and pushing out Treasuries.? But it is not expanding its balance sheet.? After several novel policy initiatives, it should be painfully obvious to Fed-watchers that the lack of increase in the monetary base is intentional.
The Fed is trying to influence financing in the residential mortgage market versus Treasuries, in the short run.? It is not trying to stimulate the economy through expanding the monetary base.
The short-run aspect of the program hobbles it to some degree.? The Fed can say that they will continue to finance in the short term indefinitely, but nothing says that louder than expanding the terms from 28 days to two years.? If it’s in the agreement, the expanded length of financing will get a much bigger result than a rolling four week window.? Think of it this way: the Fed might want to continue the short-term financing indefinitely, but there have been times in the past where the Fed has felt forced to abandon a plan because of global macroeconomic events (think 1986-7, when the dollar fell, then the bond market fell, then the stock market fell…).? Promises are one thing, contractual terms are another.
I’m not a fan of central banking, but if we are going to have central banking, this is a time when the monetary base should be expanding, at least modestly.? I think the Fed in this case is being “too clever” and needs to do a permanent injection of liquidity.? If they don’t want to do that, well, let’s move back to the gold standard, and privatize monetary policy.
These short-term financing arrangements (TAF & TSLF) are an attempt of the Fed to redirect liquidity from ordinary channels (fed funds and the like), to the short-term funding of banks and dealers with acceptable collateral. Acceptable collateral varies, with differing haircuts depending on the collateral and the financing program. At this point, Agency MBS and AAA whole loans (not on review for downgrade — presumably that means no negative outlooks from any ratings agency) are encouraged.What I find most interesting in all of this how little true liquidity the FOMC has injected in this cycle. The monetary base is flat. What this looks like is an attempt to selectively reflate the economy — help the banks and dealers, but keep total liquidity close to fixed.
And, in the face of this, total bank liabilities keep expanding at a 10%+ clip. It almost feels like any source of liquidity is good liquidity to the banks. Of course, they get a lot of it from the FHLB, which has been the big unconstrained lender in this cycle. Fannie and Freddie may now be able to make larger loans, which loosens up hosing finance a bit, but only the FHLB has the balance sheet to do so in this cycle, and they have done it. Call them the “shadow Fed.” But even their balance sheet is finite, and they are only implicitly backed by the US Government, like Fannie and Freddie.
So where does this leave us? Muddling along. Even the redirection of liquidity will not get the banks and dealers too jazzed, because they are only short term measures, with uncertain long-term funding availability and cost. More attractive than the “free” market for now, but that’s about it.
The Fed is trying some clever ideas. I have just two concerns — what happens when you unwind them, and are they perhaps too clever?? There may be unintended consequences…
Keynes said, “In the long run, we are all dead.”? Now, those of of us who believe in Jesus Christ would object, but that’s not my purpose for writing here.? At present, the FOMC is pursuing a short-term strategy to reliquefy the short-term markets through the TAF and other means, leaving the long-term inflationary results to play out as they will.? As they do this, they listen to the strains from banks and other lenders and ignore the price signals from food and energy, which are in greater demand globally.
Long-term rationality would have the Fed stop about now, because the present yield curve is adequate to stimulate the economy. I argued that at RealMoney, when the Fed started raising rates above 3%.? Overshooting would lead to bad results.? The same is true here on the flip-side. Lowering rates by too much will create its own troubles,
The Fed likes to talk about its “independence,” but really it has little, unless it is willing to make some politically unpopular moves, and not lower rates much further.
I’ll tell you what I expect: the FOMC will lower the Fed funds rate by 50-75 basis points at the meeting on 3/18.? They follow the market; they don’t lead it.? Even though loosening does little good for dodgy financial companies, they loosen in hope that they might end the leverage crisis.
I always try to separate my views of what I think the FOMC will do, versus what the FOMC should do. It’s hard for me now, because I think the FOMC is pursuing the wrong strategies. The yield curve is steep enough now, that further easing will not yield much incremental benefit. Further, a loose monetary policy only stimulates healthy areas of the economy that can absorb more borrowing, not areas with impaired balance sheets.
But what will the Fed do? Loosen. Aggressively. Don Quixote would be proud. They will make the TAF permanent and big, and the discount window will be a relic of a simpler age.
Let’s think of the short run versus the long run. In the short run, the FOMC wants to get the economy moving again, and is willing to tolerate negative real interest rates in order to do so. The Fed funds target is already 1%+ below the CPI, and the argument is over whether the next move will be to loosen 50 or 75 basis points. Negative real interest rates promote goods and services price inflation. (I don’t know about everyone else, but when filling up my gas tank nears $100 I begin to worry. Eight kids — 15-seat van, 10 cylinders…) In the long run, the FOMC will have to deal with price inflation. Even with the current yield curve, I can tell you that goods price inflation will worsen, leading to monetary tightening that will be painful, or no tightening, and inflation that rivals the 70s.
The Fed could target lending to the weak areas of the economy, while leaving monetary policy alone. That would invite charges of favoritism, which is why it won’t happen.
So, in my opinion, asset deflation will persist, and goods price inflation will increase. As for me, I will likely sell my positions in Deerfield Capital, Royal Bank of Scotland, and Deutsche Bank on Monday, replacing the exposure with an index for now. I have agonized over the seemingly cheap capital markets names for some time now, and I have been the loser there. I will return, but for now, it is safer to have no investment banking or mortgage exposure. The asset deflation is hitting them hard, and lending is contracting.
Sorry, not a bill pass.? It was an outright sale, probably to adjust for the increase in the TAF.? Thanks to jck at Alea for correcting me.
So, still no permanent injection of liquidity since 5/7/2007.? This has to be a record, particularly in a loosening cycle.? One month ago, I asked the NY Fed if it was a record.? They never responded to me.
First permanent injection of funds in 10 months.? A bill pass.? Now, it qualifies as permanent, but the $10 billion injection will only last 2-3 months.? Not very permanent to me.
I suspect that these measures can succeed in bring the TED spread down for now, but unless they make the TAF permanent, there will be an effect when they unwind it. ? What these measures can’t do is unjam our mortgage markets.? A coupon pass where they buy some agency debt would make a nice statement.
There are times where I feel the intellectual well is dry, and I come to my keyboard and say, “What do I write tonight?” This is not one of those times. I have too many things to write about, and not enough time. I’ll see how much I can say that is worth reading.
1)Jimmy Rogers (I?ve met him once ? a nice guy) tends toward the sensational.There is a grain of truth in what he says, but the demographic situation in China is worse than that in Japan, which is why they Communist leadership there is considering eliminating the one-child policy:
I gave a talk last October, which included a lot on the effects of demographics on the global economy:
Now, eliminating the one-child policy won?t do that much, because most non-religious women in China don?t want to have kids. In developed societies, once women don?t want children or marriage, no level of economic incentive succeeds in changing their minds.
This isn?t meant to be social commentary.The point is that there is a global demographic shift of massive proportions happening where there will be huge social pressures on retirement/eldercare systems, because the ratio of workers to retirees will fall globally.China will be affected more than most, and the US less than most (if we can straighten out Medicare).
The economic effect will feel a little stagflationary, with wage rates improving in nominal terms, taxes rising to cover transfer payments, and assets being sold (to whom?) to fund retirements and healthcare.There need not be a crisis, like a war over resources, in all of this, but it won?t be an easy next 30 years.One thing for certain, when you look at labor, capital, and resources at present, the scarcest of all is resources.Again, resource price inflation.At present, capital is scarcer than labor, but that will flip in the next 30 years.
2) A few e-mailers asked for more data on how I view monetary aggregates. On monetary aggregates, my view of it is a little different than most, and I take a little heat for it. Ideally, the lower level monetary aggregates indicate a higher degree of liquidity; greater ease and shorter time of achieving transactions. The other way to view it is how sticky the liability structure is for the banks. Demand deposits, not sticky. Savings accounts, stickier. Money market funds, stickier still. CDs, even stickier.
As the Fed changes monetary policy, there are tradeoffs. Willingness of the public to hold cash, versus opportunity at the banks to make money from borrowing short and lending longer, versus banking regulators trying to assure solvency.
That’s why I look at the full spectrum of monetary measures. They tell a greater story as a group.
3) No such thing as a bad asset, only a bad price? No such thing as a bad asset, only a mis-financed asset? Both can be true. What we are experiencing today in many markets is that many assets were financed with too much debt and too little equity. In the process, because of the over-leverage allowed for high returns on equity to be generated from low returns on assets, the buyers of risky assets overpaid for their interests.
This has taken many forms, whether it was Subprime ABS, CDOs, SIVs, Tender Option Bonds, the correlation trade, etc. Also the borrow short, lend long inherent in Auction Rate Securities, TOBs, and other speculations that make wondeful sense occasionally, but players stay too long.
Rationality comes back to these markets when “real money buyers” appear (pension plans, insurance companies, wealthy dudes with nose for value), and these non-traditional buyers soak up the excess supply of investments that are out of favor, and do it with equity, at prices that make the unlevered return look pretty sweet. This is how excess leverage gets purged from the system, and how pricing normalizes, with losses delivered to the overlevered.
4) As I said in my post last night, there is value in the tax-free muni market for non-traditional buyers. Is this the bottom? Probably not, but who can tell? Smart buyers will put a portion of a full position on now, and add if things get worse. Don’t put a full position on yet. I eschew heroism in trading, in favor of a risk-controlled style, where one makes more on average, but protects the downside. It is possible that the drop in prices will bring out more sellers, but I think that there will be more buyers in the next week. That said, the leveraged buyers need to get purged out of the muni markets.
Interesting to note on Barry’s blog that he has noted that the “low quality” trade has been so stunning over the past three years. I thought Richard Bernstein at Merrill and I were the only ones who cared about this stuff. But now for the bad news: the trade won’t be over until high yield spreads start blowing out, and presently, they show no sign of doing that. Why? There haven’t been many defaults, for one reason. The few defaults have been for the most part in auto parts and airlines. There’s no systemic panic.
Beyond that, there’s a lot of capital to finance speculative ventures, and to catch bad ones when they fall. That means that marginal ideas are getting forgiveness as they get refinanced.
The demand for yield is huge, which drives the offering of protection in the credit default swap market. Fund of funds encourage hedge funds to seek steady income, which makes them tend to be insurers against default risk, rather than speculators on possible default.
I know that I wrote “Default Cycle Will Turn Nasty in 2007;” I take my calls seriously, because I have money on the line, and many of you do too. I think the low quality trade, absent a market blow-up, won’t outperform by a lot in 2006, but will still outperform. Something needs to happen to make credit spreads not look like a free lunch.
My best guess of what will do that is the seasoning of aggressive corporate bond issuance in 2004 and 2005. Bad credit be revealed for what it is, and even the stocks of low quality companies that eventually survive will get marked down for a time, as strong balance sheets get rewarded once again.
Position: none
Then later, in early 2007, I wrote: I was wrong on underperformance of junk bonds. Tight levels got even tighter, with an absence of significant defaults. Junk bonds led the bond market in 2006. In 2007, I don’t expect a repeat, but I do expect defaults to start rising by the end of 2007, leading to a widening in spreads and some underperformance of junk bonds. The real fun will come in 2008-2009. Corporate credit cycles last four to seven years, and the last bear phase was 2000-2002. We’re due for a correction here.
Well, I got it close to right. Timing is tough.
6) Would you pay a high enough price to buy a short-dated TIPS with a negative real yield? Yes you might, if you were hedging against nominal Treasuries, with the CPI running ahead at 4%, and short-dated (5 years and in) nominal bonds at 2 1/2% and lower. As it is, the market seems to be hesitating at going negative, but in my opinion it will, until the concern of the FOMC changes to price inflation.
7) Wilbur Ross didn’t get rich by being dumb. He didn’t buy stakes in MBIA or Ambac, but in one of the two healthy firms, Assured Guaranty. Better to take a stake in the healthy firm in a tough market; they will survive, and write the business that their impaired competitors can’t. This just puts more pressure on MBIA and Ambac, and provides a lower cost muni insurance competitor to Berky.
8 ) MBIA and Ambac are playing for time, and I don’t mean that in a bad way. They are willing to shrink their balance sheets, and write little if any structured business, pay principal and interest in dribs and drabs, and pray that S&P and Moody’s give them the time to do this, and keep the AAA/Aaa intact. It could be three years, and stronger players (FSA, BHAC, AGO) will absorb their non-structured markets. But it could work. If I were Bill Ackman, I would take off half my positions here. Just a rule of thumb for me, when I am managing institutional assets and I become uncertain as to whether I should buy or sell, I do half, and then wait for more data.
Remember, many P&C insurers have been technically insolvent (in hindsight) during the bear phase of the underwriting cycle. They survived by writing better business when their balance sheet was in worse shape than commonly believed. The financial guarantors have a unique ability to wait out losses.
9) There have been all sorts of articles asking whether XXX institution is “too big to fail?” Well, let me “flip it” (sending my pal Cody a nickel for his trademark 😉 ) and ask, “Is the US too big to fail?” There’s a reason for my madness here. “Too big to fail” means that the government will bail out an entity to avoid a systemic crisis. Nice, maybe, but that means the government raises taxes to do so (nah) or issues debt that the Fed monetizes, leading to price inflation. Either way, the loss gets spread over the whole country.
What would a failure of the US look like? The Great Depression springs to mind. Present day Japan does not. They are not growing, but they aren’t in bad shape. Another failure would be an era like the 1970s, but more intense. That’s not impossible, if the Treasury Fed were to rescue a major GSE via monetary policy.
10) I have had an excellent 4Q07 earnings season. As of the end of February, I am still in the plus column for my equity portfolio. But, into every life a little rain must fall… after the close on Friday. 🙁 Deerfield Capital reported lousy GAAP earnings, and I expect the price to fall on Monday. Now, to their credit:
They reduced leverage proactively, and sold Alt-A assets before Thornburg blew.
They moved to a more conservative balance sheet. It is usually a good sign when a company sells its bad assets in a crisis.
I would expect the dividend to fall to around 30 cents per quarter. I should have more to say after the earnings call. They are becoming a little Annaly with a CDO manager on board (might not be worth much until 2010).
I may be a buyer on Monday. Depends on the market action.
That’s all for this evening. Good night, and here’s to a more profitable week next week.
1) The blog was out of commission most of Saturday and Sunday, for anyone who was wondering what happened. From my hosting provider:
We experienced a service interruption affecting the Netfirms corporate websites and some of our customer hosted websites and e-mail services.
During scheduled power maintenance at our Data Centre on Saturday Feb. 23 at approximately 10:30 AM ET, the building’s backup generator system unexpectedly failed, impacting network connectivity. This affected several Internet and Hosting Providers, including Netfirms.
Ouch. Reliability is down to two nines at best for 2008. What a freak mishap.
2) Thanks to Bill Rempel for his comments on my PEG ratio piece. I did not have access to backtesting software, but now I do. I didn’t realize how much was available for free out on the web. He comes up with an interesting result, worthy of further investigation. My main result was that PEG ratio hurdles are consistent with a DDM framework within certain moderate values of P/E and discount rates. Thanks also to Josh Stern for his comments.
3) I posted a set of questions on Technical Analysis over at RealMoney, and invited the technicians to comment.
Professionals are Overrated on Fundamental Analysis
2/21/2008 5:19 PM EST
I’m not here to spit at technicians. I have used my own version of technical analysis in bond trading; it can work if done right. But the same thing is true of fundamental investors, including professionals. There are very few professional investors that are capable of delivering above average returns over a long period of time. Part of it is that there are a lot of clever people in the game, and that raises the bar.
But I have known many good amateur investors that do nothing but fundamental analysis, and beat the pros. Why? 1) They can take positions in companies that are too small for the big guys to consider. 2) They can buy and hold. There is no pressure to kick out a position that is temporarily underperforming. With so many quantitative investors managing money to short time horizons, it is a real advantage to be able to invest to longer horizons amid the short-term volatility. 3) They can buy shares in companies that have been trashed, without the “looks that colleagues give you” when you propose a name that is down over 50% in the past year, even though the fundamentals haven’t deteriorated that much. 4) Individual investors avoid the “groupthink” of many professionals. 5) Individual investors can incorporate momentum into their investing without “getting funny looks from colleagues.” (A bow in the direction of technical analysis.)
When I first came to RM 4.4 years ago, I asked a question of the technicians, and, I received no response. I do have two questions for the technicians on the site, not meant to provoke a fundy/technician argument, but just to get opinions on how they view technical analysis. If one of the technicians wants to take me up on this, I’ll post the questions — hey, maybe RM would want to do a 360 on them if we get enough participation. Let me know.
I received some e-mails from readers asking me to post the questions that I mentioned in the CC after the close of business yesterday. Again, I’m not trying to start an argument between fundies and techies. I just want to hear the opinions of the technicians. Anyway, here goes: 1) Is there one overarching theory of technical analysis that all of the popular methods are applications of, or are there many differing forms of technical analysis that compete against each other for validity (and hopefully, profits)? If there is one overarching method, who has expressed it best? (What book do I buy to learn the theory?)
2) In quantitative investing circles, it is well known (and Eddy has written about it recently for us) that momentum works in the short run, and is often one of the most powerful return anomalies in the market. Is being a good technician just another way of trying to decide when to jump onto assets with positive price momentum for short periods of time? Can I equate technical analysis with buying momentum?
To any of you that answer, I thank you. If we get enough answers, maybe the editors will want to do a 360.
Position: none
I kinda thought this might happen, but I received zero public responses. I did receive one thoughtful private response, but I was asked to keep it private. Suffice it to say that some in TA think there is a difference between TA and chart-reading.
As for me, though I have sometimes been critical of TA, and sometimes less than cautious in my words, my guesses at the two questions are: 1) There is no common underlying theory to all TA, there are a variety of competing theories. 2) Most chart-readers are momentum players, as are most growth investors. Some TA practitioners do try to profit from turning points, but they seem to be a minority.
I’m not saying TA doesn’t work, because I have my own variations on it that I have applied mainly to bond investing. But I’m not sure how one would test if TA in general does or doesn’t work, because there may not be a commonly accepted definition of what TA would say on any specific situation.
Um, after reading this article at the Financial Times, I thought it would be a good idea for me to point readers to my article that explained the 2005 Correlation Crisis. Odds are getting higher that we get a repeat. What would trigger the crisis? A rapid decline in creditworthiness for a minority of companies whose debts are referenced in the relevant credit indexes, while the rest of the companies have little decline in creditworthiness. One or two surprise defaults would really be gruesome.
Just something to watch out for, as if we don’t have enough going wrong in our debt markets now. I bumped into some my old RM articles and CC comments from 2005, and the problems that I described then are happening now.
Position: none, and there are times when I would prefer not being right. This is one of them. Few win in a bust.
There are situations that are micro-stable and macro-unstable, and await some force to come along and give it a push, knocking it out of its zone of micro-stability, and into a new regime of instability. When you write about situations like that before the fact, it is quite possible that you can end up wrong for a long time. I wrote for several years as RM about overleveraging credit, mis-hedging, yield-seeking, over-investment in residential real estate (May 2005), subprime lending (November 2006), quantitative strategies gone awry, etc. The important thing is not to put a time on the prediction because it gives a false message to readers. One can see the bubble forming, but figuring out when cash flow will be insufficient to keep the bubble financed is desperately hard.
5) This brings up another point. It’s not enough to know that an investment will eventually yield a certain outcome, for example, that a distressed tranche of an ABS deal will eventually pay off at par. One also has to understand whether an investor can handle the financing risks before receiving the eventual payoff. Will your prime broker continue to finance you on favorable terms? Will your regulator force you to put up more capital against the position? Will your investors hang around for the eventual payoff, or will they desert you, and turn you into a forced seller? Can your performance survive an asset that might be a dud for some time?
This is why the price path to the eventual payoff matters. It shakes out the weak holders, and moves assets that should be financed by equity onto strong balance sheets. It’s also a reason to be careful with your own balance sheet during boom times, and in the beginning and middle of financial crises — don’t overextend your positions, because you can’t tell how long or deep the crisis might be.
6) I agree with Caroline Baum; I don’t think that the FOMC is pushing on a string. The monetary aggregates are moving up, and nominal GDP will as well… it just takes time. The yield curve has enough slope to benefit banks that don’t face a lot of credit problems… and the yield curve will steepen further from here, particularly if the expected nadir of Fed funds drops below 2%. Now, will real GDP begin to pick up steam? Not sure, the real question is how much inflation the Fed is willing to accept in the short run as they try to reflate.
7) Now, inflation seems to be rising globally. At this point in the cycle, the FOMC is ahead of almost all major central banks in loosening policy. I think that is baked into the US dollar at present, so unless the FOMC gets even more ahead, the US Dollar should tread water here. Eventually inflation elsewhere will get imported into the US. It’s just a matter of time. That’s why I like TIPS here; eventually the level of inflation passing through the CPI will be reflected in implied inflation rates.
8 ) Okay, MBIA will split in 5 years? That is probably enough time to strike deals with most everyone that they wrote coverage for structured products, assuming the losses are not so severe that the entire holding company is imperiled. If it’s five years away, splitting is a possibility, but then are the rating agencies willing to wait that long? S&P showed that they are willing to wait today. Moody’s will probably go along, but for how long?
9) I found it interesting that AQR Capital has not been doing well in 2008. When quant funds did badly in the latter half of 2007, I suffered along with them. At present, I am certainly not suffering, but it seems that the quants are. I wonder what is different now? I suspect that there is too much money chasing the anomalies that the quant funds target, and we reached the end of the positive self-reinforcing cycle around mid-year 2007; since then, we have been in a negative self-reinforcing cycle, with clients pulling money, and the ability to carry positions shrinking.
10) Now some graphs tell a story. Sometimes the story is distorted. This graph of the spread on Fannie Mae MBS is an example. Not all of the spread is due to the creditworthiness of Fannie Mae. Those spreads have widened 30 basis points or so over the past six months for Fannie’s on-the-run 5-year corporate bond, versus 50 basis points on the graph that I referenced. So what’s the difference? Increased market volatility makes residential MBS buyers more skittish, and they demand a higher yield for bearing the negative optionality inherent in RMBS. Fannie and Freddie are facing harder times from the guarantees that they have written, and the credit difficulties at the mortgage insurers, but it would be difficult to imagine the US Government allowing Fannie or Freddie to default on senior obligations.
That’s another reason why I like agency-backed RMBS here. You’re getting paid a decent spread to bear the risks involved.
11) I would be cautious about using prics from CMBX, ABX, etc., to make judgments about the cash bonds that they reference. It is relatively difficult to borrow and short small ABS and CMBS tranches. It is comparatively easy to buy protection on the indexes, the only question is what level does it take to induce another market participant to sell protection to you. When there is a lot of pressure to short, prices overshoot on the downside, and stay well below where the cash bonds would trade.
12) One last point, this one coming via one of our dedicated readers passing on this blurb from David Rosenberg at Merrill Lynch:
A client sent this to us last week
It was a New York Times article by Louis Uchitelle in December 1990 on the housing and credit crunch. In the article, there is a quote that goes like this ? ?This is different from the experience of the Great Depression, but something related to the 1930?s is beginning to happen?. Guess who it was that said that (answer is at the bottom of the Tidbits).
Answer to question above
?Ben Bernanke, a PrincetonUniversity Economist? (and future Fed chairman, but who knew that then?).
My take: it is a very unusual time to have a man as Fed Chairman who is a wonk about the Great Depression. That makes him far more likely to ease. The real question is what the FOMC will do if economic weakness persists, and inflation continues to creep up. I know that they want to save the day, and then remove all policy accomodation, but that’s a pretty difficult trick to achieve. In this scenario, I don’t think the gambit will work; we will likely end up with a higher rate of price inflation.
Perhaps I should start with a small apology because my post yesterday did not even consider the forthcoming release of the FOMC minutes.? Not that I would have had anything great to say, but being asleep is being asleep. 😉
1) I’ve been banging the increasing inflation drum for a few years, and now I think inflation is getting some traction.? There was the CPI report today, of course, but I don’t put too much stock in monthly numbers — there is too much noise.? (I don’t think anyone wonders why I don’t spend a lot of time on quarterly, monthly or weekly data releases, but if anyone does wonder, it is because the signal to noise ratio is low.? The shorter the period, the lower it gets.)? I follow a melange of public and private bits of data, but try to look at it over longer periods of time — at least a year if possible.? A rise in inflation will make the FOMC’s life difficult.? I have been arguing for asset deflation and price inflation for some time now, and that is not a mix that I would enjoy trying to manage, if I were on the FOMC.
2) But there’s another reason why I have been arguing for price inflation.? It was about four years ago that I suggested on RealMoney that the cycle would end when China begins to experience a bout of price inflation.? Well, we are there now.? It was simple for China (and other nations) to ship us goods or provide services when the US Dollar was stronger, and inflation was low.? It is much harder with a weaker dollar, and rising price inflation.? The people of China need American goods, not more paper promises stuffed inside their central bank.
3) A few central banks aside from the Fed have loosened recently, but not many, and not much.? The US is walking alone here, and other nations are trying to cope.? Many other countries are willing to let their economies slow a bit, and perhaps let their currencies rise versus the US dollar in order to reduce inflation.? A few are still tightening.? The inflationary impacts of our monetary policy continue to radiate out, and will continue to, until the Fed starts its next tightening cycle.
4) The way I understand the FOMC’s behavior at present, is that they will drop rates hard for a time, and then remove policy accommodation dramatically once normal economic activity resumes.? My concern is that it may be more difficult removing policy accommodation than many suppose.? The TAF is holding down the TED spread at present, though the TED spread is still high.? What happens when it goes away?? Extending liquidity is always easier than removing it.? And, as it said in the 1/21/2008 portion of the FOMC minutes:
Some members also noted that were policy to become very stimulative it would be important for the Committee to be decisive in reversing the course of interest rates once the economy had strengthened and downside risks had abated.
The FOMC is not intending on letting low short rates remain for a long time.? That would make me queasy if I had a lot of money riding in the belly of the yield curve, say 4-7 years out.
5)? How would I characterize the FOMC minutes, then?? Weak economy, but not a shrinking economy.? Difficulties in the lending markets; credit spreads are high.? Inflation higher than we would like, but economic weakness, especially that affecting the financial system comes first.
6) From yesterday, my friend Dr. Jeff asked:
What was the Fed reply about M3?? I have continuing curiosity about this topic, as you know.? My economist friends tell me that it is not a useful measure.? It includes elements that are exchanges not increasing monetary supply and is also not subject to policy action.? MZM is interesting, but distorted by investors selling stocks and going to cash.? The latest macro textbooks stick to M2.
Meanwhile, many wingnuts (not you of course) see the dropping of the M3 reporting as some conspiratorial move.? They credit large government bureaucracies with much more conspiratorial power than could possibly be mustered!
By reading actual transcripts, you have vaulted into the top 1% of Fed analysts – if you were not there already 🙂
The nice fellow at the Fed who e-mailed me back confirmed that I should be looking at the H.8 report for an M3 proxy.
If you’re not into monetary policy, you can skip this. Within the month, the Federal Reserve will stop publishing M3. Now, I think M3 is quite useful as a gauge of how much banks are levering themselves up in terms of credit creation, versus the Fed expanding its monetary base. I have good news for those anticipating withdrawal symptoms when M3 goes away: The Federal Reserve’s H.8 report contains a series (line 16 on page 2 – NSA) for total assets of all of the banks in the US. The correlation between that and M3 is higher than 95%, and the relative percentage moves are very similar. And, from a theoretical standpoint, it measures the same thing, except that it is an asset measure, and that M3 incorporated repos and eurodollars, which I think are off the balance sheet for accounting purposes, but should be considered for economic purposes.
But it’s a good substitute… unless Rep. Ron Paul’s bill to require the calculation of M3 passes, this series will do.
Position: noneI since modified that to be total liabilities, and not total assets.? My use of M3 is a little different than most economists.? There is a continuum between money and credit, and M3 is more credit-like, while measures that don’t count in time deposits are money-like.? My view of M3 was versus other monetary measures, helping me to see how much the banking system was willing to borrow from depositors in order to extend credit.? As an aside, non-M2 M3 growth is highly correlated with stock price movement (according to ISI Group).
7) I give credit to the members of the FOMC who said (regarding the intermeeting 75 bp rate cut):
However, some concern was expressed that an immediate policy action could be misinterpreted as directed at recent declines in stock prices, rather than the broader economic outlook, and one member believed it preferable to delay policy action until the scheduled FOMC meeting on January 29-30.
This is just an opinion, but on policy grounds, I would have found it preferable for the FOMC to have cut 125 basis points on the 30th, rather than the two moves.? I don’t believe that the FOMC should react to short-term market conditions, and in general, they should avoid the appearance of it.? Monetary policy works with a long and variable lag.? One week would not have mattered; the FOMC needs to consider the way their actions appear, as well as what those actions are.
I like variety at my blog.? I like to think about a lot of issues, and the interconnections within the markets.? Sometimes that makes me feel like a lightweight compared to others on critical issues.? But what I am is a stock and bond investor who analyzes the economy to make better investment decisions, primarily at the sector level, and secondarily at the asset class level.
At present, analyzing the FOMC is a little confusing.? Why?
We have Fed Governors speaking their minds, because Bernanke doesn’t maintain the control that Greenspan did.? Thus we hear a variety of views.
The economy is neither strong nor weak, but is muddling along.
The Dollar is weak, but doesn’t seem to be getting weaker; it seems that a pretty accommodative forecast of FOMC policy has been baked in.
MZM and my M3 proxy are running ahead at double-digit rates, while M2 trots at around 6%, and the monetary base lags at a 2% rate.? We are now more than nine months since our last permanent injection of liquidity.? I asked the Federal Reserve in an e-mail to tell me what the longest time was previously between permanent open market operations one month ago, but they did not respond to me.? (They did respond to me when I suggested my M3 proxy, total bank liabilities.)
The Treasury yield curve still has a 2% Fed funds rate in 2008, but the recent curve widening should begin to inject some doubt into the degree of easing that the Fed can do.? Once yield curves get near maximum steep levels, something bad happens, and the loosening stops.? At a 2% Fed funds rate, we will be near maximum steep.
The TAF auctions have reduced the TED spread to almost reasonable levels, but it almost seems that the Fed can’t discontinue the auctions, because the banks have found a cheap source of financing for collateral that can’t be accepted under Fed funds.
At present, I see a 50 basis point cut coming at the 3/18 meeting.? That’s what fits the yield curve, Fed funds futures, and the total chatter.? For the loosening trend to change, we will need something severe to happen, such as a inflation scare or a dollar panic.
Now the equity markets are not near their peak, but the debt markets are showing more fear, and that is what is motivating the Fed.? Capital levels at banks?? Credit spreads on bonds?? Ability to get financing?? The Fed cares about these things.
In some ways, Bernanke cares the most.? Of all the people to have in the Fed Chairman seat at this time, we get a man who is a scholar on the Great Depression, and determined to not let it happen again, supposing that it was insufficient liquidity from the Federal Reserve that led to the Depression.? That might not have been the true cause, but it does indicate a Fed biased toward easing, until price inflation smacks them hard.
One last note.? Though I haven’t read through the 2001 transcripts of the FOMC, I have scanned the 1999 and 2000 transcripts.? The FOMC is flexible in the way that they view policy, and willing to consider things that aren’t perfectly orthodox, such as the stock market, even if it is hidden in the rubric of the wealth effect.
