With QE2 "Sealed", Next Rate Hike Won't Come Until 2015 Says Goldman
Jan Hatzius pretty much slams the door on any possibility for a liquidity moderation (let alone exit): "We found that under our own economic forecasts it might take until 2015 or longer before a rate hike became appropriate." In other words, the US economy will very likely just go down in flames, as the Fed makes sure that each and every American is infinitely "rich" courtesy of zero cost debt denominated in worthless dollars. The only salvation from this outcome is for the rest of the world to stage a Fed intervention before it all burns down. Of course by that point, the next reserve currency will be in tow, and few if any will care what happens to that particular former superpower. And just the message is heard loud and clear, Hatzius says that even with a QE of over $100 billion (but under $150 billion) monthly will hardly proceed to rescue the economy: "Even after the next 6-9 months, we still see still plenty of headwinds that will keep the growth pace slow by historical US recovery standards. And in an absolute sense the economy is unlikely to look good for a long time to come, especially from the perspective of unemployed workers who will continue to face difficulty finding jobs." This, however, will not prevent speculators, now awash with more free money than they could ever imagine, from opening commodities limit up each and every morning until the end consumer finally realizes that $5 gas/$10 milk does not quite jive with the core CPI lies.
Full Hatzius note:
1. Friday’s jobs numbers put the seal on a quantitative easing announcement at the November 2-3 FOMC meeting. Excluding Census layoffs, the economy lost 19k jobs in September, the weakest since December 2009. The private sector logged a 64k employment gain, but this was more than offset by an 83k drop in state and local jobs, concentrated among teachers. In addition, the preliminary benchmark revision (to be finalized early next year) suggests that the economy lost 366k more jobs between March 2009 and March 2010 than initially estimated. In contrast to the weak establishment survey, the household survey was mixed but on balance slightly better than expected.
2. What will the Fed do? The data over the next three weeks will matter for the details, but right now we expect an announcement of something like $500bn in purchases through the spring or summer of 2011, coupled with a strong signal that they are prepared do more if needed. Indeed, it is also possible that they will announce a monthly purchase rate of perhaps $100bn until their inflation forecast returns to levels closer to their mandate. Whichever way the announcement is structured, we expect the monthly purchase rate to be below the $150bn pace seen in the spring and summer of 2009.
3. The FOMC is also still thinking about other ways to ease financial conditions, in particular via changes in its communications. While the point of asset purchases is to bring down the term premium at the longer end of the yield curve, the point of changes in communication is to convince the market that the funds rate will stay low for even longer than is now discounted. So the two policies are very complementary.
4. To achieve a further drop in fed funds rate expectations, we have argued that the chairman might want to give a detailed speech about “optimal monetary policy” models showing that it might take several more years before a hike in the funds rate becomes appropriate. We found that under our own economic forecasts it might take until 2015 or longer before a rate hike became appropriate (although we emphasized that this was a scenario projection rather than a formal forecast). Another example is the article by Glenn Rudebusch of the San Francisco Fed available at http://www.frbsf.org/publications/economics/letter/2010/el2010-18.html, which currently would also seem to imply no hikes until late 2012 or early 2013 (the precise date depends on the FOMC’s new forecasts to be released in the November minutes). If the Chairman presented his own version of this type of analysis, this would not be a “commitment” because it would be based on uncertain forecasts. But a detailed explanation by Bernanke of just how long the funds rate might stay near zero could nevertheless help lower bond yields and ease financial conditions further, and thereby complement the QE2 announcement.
5. So will it work? QE2 and its impact on financial conditions is one key reason why we expect the economy over the next 6-9 months to be only “fairly bad” (1%-2% GDP growth, a gradual increase in the unemployment rate, and modest further disinflation) rather than “very bad” (a renewed recession with outright declines in GDP). Other reasons are that bank credit quality is improving gradually and activity in the cyclical sectors of the economy is already so depressed that renewed large-scale declines are unlikely. There are still some significant recession risks out there, most notably (a) a bigger-than-expected house price decline driven by the large-scale supply overhang and (b) a sharper-than-expected turn to fiscal restraint, i.e. a full expiration of the 2001-2003 as well as 2009 tax cuts. But barring these risks, the more likely outcome over the next 6-9 months is below-trend growth rather than recession.
6. Even after the next 6-9 months, we still see still plenty of headwinds that will keep the growth pace slow by historical US recovery standards. And in an absolute sense the economy is unlikely to look good for a long time to come, especially from the perspective of unemployed workers who will continue to face difficulty finding jobs. Also, because of the large output gap, inflation is likely to fall somewhat further and the funds rate is likely to stay near 0% for a very long time to come. But if we get through the next 6-9 months, the growth pace is likely to pick up in the remainder of 2011, from clearly below trend to about a trend pace. So the pattern should look more encouraging than in 2010.