Thoughts On Future Monetary Policy, As Rumors Kocherlakota Leaked Tomorrow's NFP Number Mount
Tomorrow's NFP number will be one of the most critical releases from the BLS: if on one hand the number is far greater than expected, it will effectively mean that QE3 will not begin immediately after the end of QE2, just like QE1 ended on March 31, 2010 only to see QE Lite implemented 4 months later. That the Fed is not willing to take a political gamble and send oil to $150 is conceivable, which is what would happen should Jon Hilsenrath start leaking QE3 rumors. On the other hand, the economy is once again turning lower as recent diffusion data (not to mention housing) has been indicating. Should the Fed implicitly tighten, by not loosening, the economic contraction will accelerate drastically, and capital markets will follow suit. And since as Hugh Hendry noted earlier, there is no China to pick up the slack, the stakes on the all in gamble in this bet that the virtuous cycle has picked up, will likely cost Bernanke his job if he ends up wrong and QE3 is needed anyway. Of course, as many believe, and as Bernanke himself has said, manipulating the market and stimulating inflation is and continues to be the Fed's only objective. Obviously, the waterfall effects in either direction here are huge. Which is why if tomorrow's NFP number is a beat and not just any beat but a massive one (read well over 250,000), it will be an attempt by the administration to cement the idea that the economy is now recovering. Anything at or below consensus will merely push the decision one month forward, however it will be too late to prepare the political landscape for QE3 in May, just two months ahead of the end of QE2. So tomorrow is likely D-Day on QE3 (or at least a direct continuation of POMO past the June 30 expiration date).
In this light, it is interesting to note what Morgan Stanley has to say of Narayana Kocherlakota's interview from late in the afternoon, which stipulated a 75 bps hike in rates as normal, and which caused a minor sell off into the close. According to David Greenlaw there are rumors that Kocherlakota may have seen, and therefore leaked, tomorrow's NFP number, which by implication would have to be very bullish, in order for the Minneapolis Fed chairman to have such strong words encouraging tightening.
From Morgan Stanley:
Kocherlakota's interview with the WSJ is getting a lot of attention (see article below). My own read is that the hawks are simply getting more concerned about inflation risk given the recent turnaround in the core CPI and the elevation in some measures of inflation expectations. The logic that Kocherlakota uses to arrive at the possibility of a rate hike of more than 50 bp later this year is fairly straightforward. If you assume that policy was appropriate at the end of 2010 and core inflation rises by one-half a percentage point, then the policy rate should be hiked by more than 50 bp. Of course, there are a couple of key assumptions involved here. Kocherlakota's estimate of a one-half percentage point rise in core PCE (to 1.3%) is actually quite close to the FOMC's central tendency forecast of +1.0 to +1.5% at the January meeting (note: our own estimate is a little higher -- +1.5%). But, Kocherlakota's starting point -- i.e., the assumption that policy was appropriate at the end of 2010 -- is one that many FOMC members would vehemently disagree with. They would counter by arguing that the policy rate would have been much lower were it not for the zero bound. Also, they would argue that the Fed is still missing on both elements of the dual mandate -- and is likely to continue to do so for quite some time. However, Kocherlakota has argued previously that the size of the output gap is unclear and the NAIRU could conceivably be as high as 7.5%. This means he is less wedded to the notion that there is no inflation risk until a lot more slack is absorbed. So, the split on the FOMC continues to widen. Along these lines, we are anxious to hear what Dudley has to say tomorrow and what Bernanke says next Monday evening.
Finally, I've heard some claims that Kocherlakota has seen tomorrow's employment report and that explains his hawkishness comments. However, there is no way this is true. Only the Fed Chairman gets the report ahead of time (late in afternoon on the day prior to release) and he doesn't even share it with the other governors -- never mind the regional bank Presidents.
If Morgan Stanley says there is no way something is true, it means absolutely the opposite. As if Ben Bernanke can keep anything to himself with Larry Meyer always holding on Line 293. But that's not the point: the issue is that if NFP comes surging then all is well, and indeed Kocherlakota indeed leaked his advance knowledge of the payroll number to the public. If on the other hand NFP comes inside of expectations, then the Fed hawks will have a reset, and a fresh opportunity to reevaluate their tightening expectations. Which is precisely what happened exactly a year ago.
On the other hand, statistics are not on the side of the employment bears: as John Poehling demonstrates, the March "Adjustment Factor", due tomorrow, has added on average 834,000 jobs with a median of 895,000 jobs and a range of 619,000-1,035,000: a 419,000 range. Which means that there are all the makings for a good spillover effect from the seasonal adjustment into the actual NFP number.
But no matter which way the NFP pendulum swings tomorrow, and if there is a blow out jobs number look for the market to take a deep dive as that loud sucking noise you hear will be the NPVing of the excess liquidity out of the market, the practical reality of the Fed selling any of its $1.4 trillion in Treasurys at the same time as the Treasury has to offload about $2.5 trillion in gross debt in the next 12 months (a rather necessary precondition to tightening), seems beyond incredulous.
Which leaves just one possibility in the open, and one which has received no discussion by the general public: namely, that the Fed will continue to monetize debt even as it hikes: a perfect compromise for the Hawks and Doves, and a process that will likely be tinkered with by Jean Claude Trichet as soon as a week from now. While the two processes are somewhat mutually exclusive, the ongoing monetization of the US debt is critical, while hiking rates may do wonders for inflation expectations. Furthermore, since the market will have no idea how to react for a good 6-9 months, the Fed will have bought the ever critical time it needs for at least one more bonus season on Wall Street before there is a another major market puke on the realization that this last ditch attempt at kicking the can down the road is a failure.
Whether this is the outcome considered by the Fed currently, we have no idea, but expect to find out soon enough.
All we know is that tomorrow's NFP number will most certainly be one very much appropriate to the whole April 1 tradition, courtesy of the BLS.
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