Monetary Policy

What a guy ...

Yu Yongding: "Europe’s courtship of Beijing is moving to a more intense level. Klaus Regling, the chief of the eurozone bail-out fund, is in Beijing discussing possible support. Just a few days ago French President Nicolas Sarkozy conferred with Hu Jintao, his Chinese counterpart, to win Beijing’s support. They should not hold out their hopes too high. The two will have had a courteous hearing: China is willing and able to help. Since the beginning of Europe’s sovereign debt crisis, Beijing has repeatedly expressed its wish to offer “a helping hand” to Europe. Eurozone countries, however, have to understand that they will have to save themselves. Expectations of a “red knight” riding to the rescue are sorely misplaced."

With actual economic data now largely irrelevant, and why should it be : "got a recession? There's an EFSF for that" it is hardly worth noting that the third notable economic data point of the day, the first being GDP which came in line on an inexplicable surge in consumer spending in Q3 despite an epic collapse in consumer confidence, and a drop in the market to 2011 lows; the second being the nth consecutive print in initial claims over 400, which was the pending home sales update from the NAR which printed at -4.6% on expectations of an increase of 0.4%, and down from last month's -1.2%. This is the third consecutive monthly slide in sales data, and merely adds to yesterday's near record drop in median home prices, once again simply confirming that the biggest source of US "wealth" housing still has a long way to drop. And while we ridicule him all the time, even the NAR's Larry Yun has figured out that operation twist and monetary policy in general is a failure: "The Federal Reserve evidently has been attempting to lower mortgage rates, yet more consumers are faced with taking out jumbo loans that carry higher interest rates." Speaking of Jumbo loans, PrimeX jumped earlier today on the European news, and has since been drifting lower. It will continue doing so once some semblance of rationality returns.

Gold has fallen in all currencies today as equity and commodity markets have seen weakness due to concerns about Chinese economic growth after China's economy eased somewhat. Germany’s pouring cold water on the likelihood of a speedy resolution of the euro zone's debt crisis and the summit this weekend has also increased market jitters. Gold continues to be correlated with equities in the short term but we are confident that this correlation is short term in nature and the inverse correlation between gold and equities and bonds will again be seen in the medium and long term. Peripheral European debt markets are showing weakness again. The recent trend of falling yields appears to have ended which is worrying. Should yields begin to rise again this should create added safe haven demand for gold. UK inflation rose to match a record high of 5.2% (CPI) and retail price inflation (RPI), a measure of the cost of living used in wage negotiations, accelerated to 5.6% (from 5.2%), the highest since June 1991. The figures were again worse than expected by the BoE, economists and many economic experts who have been underestimating the threat of inflation for some time. The BoE, like the Federal Reserve, continues to follow an ultra loose monetary policy in an effort to boost an economy teetering on the brink of a double dip recession.

A fascinating insight from Graham Giller of Giller Investments, who analyzes over 55 years of Treasury data to point to what is the crux of the problems of monetary policy since Greenspan took over the Fed. The Greenspan [and Bernanke] era monetary policy has altered the distribution of changes in interest rates in a way that exchanges a reduction in day-to-day 'normal' variability for a considerably higher (perhaps catastrophically higher as we are finding out this week) likelihood of extreme shocks.

Still confused by the last two days of Ben Bernanke testimony which in under 24 hours had elements of glaring contradiction? A) You are not alone and B) Judging by the market's response to the Congressional and Senatorial portions of Bernanke's testimony, not even he knows what monetary message he was trying to convey. And since all of his decisions are ultimately predicated by Goldman Sachs (either in the form of current GS employee Jan Hatzius, or former GS employee Bill Dudley) here is Goldman's take on the "Q&A on the Monetary and Fiscal Policy Outlook" based on Alec Phillips and Sven Jari Stehn's take of Humphrey Hawkins events in the past two days.

Remember the whole UK stagflation scare, where the misery index recently hit a 20 year high, as both inflation and unemployment surged to two decade highs, keeping the GBP strong on expectations of rate hikes by the BOE? Well, the stagflation is still there, but according to just released BOE minutes, there has been a sudden 180 within the Monetary Policy Committee, which has now flipflopped, and just as we predicted, has fallen back to the traditional central bank fall back plan, namely "buy more bonds" as despite surging inflation, the country's central planners once again view deflation as a greater threat. As Bloomberg reports: "Bank of England minutes showed some policy makers see a potential need for further bond purchases as the economic recovery struggles and “downside” risks to growth and inflation mount. For the majority of the nine-member Monetary Policy Committee, “the fiscal challenges in the euro-area periphery highlighted the potential for further adverse shocks to demand,” according to minutes of the June 8-9 meeting published today in London. “For some of these members, it was possible that further asset purchases might become warranted if the downside risks to medium-term inflation materialized." So the spin now is not to worry about that surging inflation: it's "transitory"... just as the imminent UK QE2 will be: "While U.K. inflation was 4.5 percent in May, more than twice the central bank’s target, Governor Mervyn King said last week that the current price surge is temporary as he defended keeping the key rate on hold to aid the economic recovery during the government’s budget cuts. Paul Fisher said yesterday that adding to the bank’s bond program remains “very much on the table” as a policy tool." Next up: a major quantitative easing episode out of Japan as the two "peripheral" developed economies attempt to fill the void left by the Fed and fail miserably, at which point Bernanke will have no choice but to get involved as well.

Another indicator of what the US "recovery" looks like come courtesy of the Chicago Fed National Activity Index. As can be seen in the chart below, one can only wonder just what recovery the US would have if it did not spend $3 trillion to kickstart the virtuous (or better make that virtual) economic cycle when it did. And by the looks of facts (and not Tim Geithner spin), the downward inflection point has now arrived. Next up: another $1-1.5 trillion in monetary stimulus, although admittedly in a form that may be slightly different from the LSAPs we have all grown used to love and expect each and every day at 11:00 am EST.

Yesterday, when we presented the Bloomberg interview of Princeton economist and former Fed vice chairman Alan Blinder, we speculated that his statement that "more easing is necessary" was the first shot across the QE3 bow. Today, Goldman's Sven Jari Stehn has fired the second one in a paper just released titled: "Fiscal Adjustment without Fed Easing: A Tall Order" in which he basically takes our conclusion from the Blinder interview to the next level. As Blinder said previously, in order to improve the once again deteriorating labor picture, more fiscal stimulus would be necessary. That, however, is impossible, especially in a Congress where everyone is now promising $4 trillion of deficit cuts over the next few years. The only difference is how this cutting will be achieved: republicans want spending cuts, while democrats are demanding tax hikes for the richest. While neither approach will work in the US without the shock of a bond-crash induced austerity, Goldman conducts an thought experiment in which it evaluates the effectiveness of a tax-based and a spending-based fiscal consolidation. While finding that on average spending based deficit reduction is more effective, it only truly works in parallel with assistance from monetary policy: be it an interest rate decrease (impossible due to ZIRP) or further Large Scale Asset Purchase (QE) program. In other words, the only thing that can prevent an economic contraction in the next 2 years of semi-austerity, will be more monetary easing.

Goldman's Take: "Overall a healthy payroll report, but not a very large surprise relative to consensus expectations. In our view, the latest job readings will not have an immediate affect on the monetary policy outlook."

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 the second day full of Fed president speeches we hear from St. Louis hawk James Bullard who spoke in Prague on recent developments in monetary policy, and delivered remarks titled “U.S. Monetary Policy: Recent Developments” as part of a central bankers panel discussion at the 19th European Banking and Financial Forum in Prague. During his discussion, Bullard explained how the Fed’s second round of
quantitative easing was “a classic easing of monetary policy” and “an
effective tool, even while the policy rate is near zero.”  He also
discussed the situation in early 2011, stating that “U.S. growth
prospects remain reasonably good for 2011.”  He added that recent global
and domestic events “present considerable uncertainty, but can be
resolved in benign ways.” Finally, Bullard talked about the path to
normalization.  “Discussion of the normalization of U.S. policy will
likely return as the key issue in 2011,” he concluded.  Overall, the presentation had a not surprisingly hawkish tone. Don't forget it was precisely a year ago that the Fed was being extremely hawkish all over again, with reverse repos flying left and right, and everyone expecting that the economic "growth" was self sustainable, until it wasn't.

The much anticipated hearing on "The Relationship of Monetary Policy and Rising Prices" chaired by Ron Paul and includes such witnesses as James Grant has started. It should be quite interesting because the last time we checked, Grant had refused to drink the Kool Aid.

Ben Bernanke, who is expected to appear before the Senate for his biannual Humphrey Hawkins presentation any second, has just released his latest Monetary Policy Report to the Congress. Some of the highlights from the report: i) Bernanke says longer-term inflation expectations will remain stable, and risk of deflation has become negligible; ii) The Fed has tools needed to withdraw stimulus, and reiterates rates will remain low for extended period; iii) A sustained oil price rise would be a threat to growth, price stability, particularly if it unmoors inflation expectations; iv) The recent rise in commodity prices likely will lead to only temporary and modest increase in US inflation; The live CSPAN webcast can be watched here.

Federal Reserve Chairman Rudolph Shalom Von Bernankestein will testify before the House Budget Committee starting at 10 am Eastern today. Congressional employees of the Fed and the Banking syndicate are expected to question the Fed's plans on avoiding inflation and the current unemployment rate. We expect more of the same "QE is working because after spending $2 trillion we got 650,000 part time jobs, and we are certain it is working because rates are surging, and wholesale mortgage are now again at the higest since April, which doesn't make sense but I am a Princeton economist (Ph.D.) and you don't get this complicated stuff."