The Doves Hit The Tape: Dudley, Lockart Plead For More QE

As expected, here come the first two doves "explaining" the reasons behind Bernanke's taper surprise last week:

  • DUDLEY SAYS FED MUST ACT ‘FORCEFULLY’ TO PUSH AGAINST HEADWINDS
  • DUDLEY: MAY TAKE CONSIDERABLE TIME TO REACH 6.5% JOBLESS LEVEL
  • DUDLEY SAYS ECONOMY STILL NEEDS `VERY ACCOMMODATIVE' POLICY

And Lockhart adds to the chorus:

  • LOCKHART SAYS FED FOCUS SHOULD BE FASTER U.S. ECONOMIC GROWTH
  • LOCKHART HAS BACKED FED'S ASSET PURCHASE PROGRAM
  • LOCKHART SEES `SOME SLOWING' IN U.S. PAYROLL GROWTH

Translation: much more "high-quality collateral" to be extracted from the system.

Some of the highlights from the just released Dudley speech:

As we move into 2014, the fiscal headwinds should abate somewhat.  As that occurs, the improving underlying fundamentals of the economy should begin to dominate, pushing up the overall growth rate.  But this is just a forecast, it has not been realized yet.  That is one reason why I supported the FOMC’s decision last week to maintain the current pace of our Treasury and mortgage-backed security purchases.  In my view, the economy still needs the support of a very accommodative monetary policy.  Adjustments to that policy need to be anchored in an assessment of how the economy is actually performing, how financial conditions are evolving, and how this affects the longer-term outlook and the risks around it. Our decisions on how to adjust our policy tools—for example, the pace of asset purchases and forward guidance with respect to the level of short-term rates—must be rooted in the ongoing flow of information that informs our judgments about the prospects for a sustainable recovery.  Decisions on the pace of asset purchase and forward guidance must be based on what is most appropriate to achieve our dual mandate objectives of maximum sustainable employment in a context of price stability.

What about the mandate to make Congress irrelevant from a governance standpoint and letting the Fed "get to work"?

Here is Dudley admitting that the main reason for no taper is... because of the impact by the Fed's own trial balloon with tapering from early this year on rates and "financial conditions"

The most notable recent headwind, of course, has been the large amount of fiscal drag this year from the payroll and income tax increases and the budget sequester.  Also noteworthy is the tightening of financial market conditions that has occurred since May. 

Additionally, Dudley does away with all pretense, and finally uses the taboo word "taper" not once but twice:

Several questions have emerged following the meeting.  Most noteworthy was—given that market expectations were skewed towards anticipating the beginning of a taper at this meeting—why the Committee did not begin to reduce the pace of asset purchases.  Although I can’t speak for the Committee, I can provide some reasons for my own decision.  

 

To begin to taper, I have two tests that must be passed:  (1) evidence that the labor market has shown improvement, and (2) information about the economy’s forward momentum that makes me confident that labor market improvement will continue in the future.  So far, I think we have made progress with respect to these metrics, but have not yet achieved success.   

 

With respect to the first metric, we have seen labor market improvement since the program began last September. Over this time period, the unemployment rate has declined to 7.3 percent from 8.1 percent.  However, at the same time, this decline in the unemployment rate overstates the degree of improvement.  Other metrics of labor market conditions, such as the hiring, job-openings, job-finding rate, quits rate and the vacancy-to-unemployment ratio, collectively indicate a much more modest improvement in labor market conditions compared to that suggested by the decline in the unemployment rate.  In particular, it is still hard for those who are unemployed to find jobs.  Currently, there are three unemployed workers per job opening, as opposed to an average of two during the period from 2003 to 2007.

 

With respect to the second metric—confidence that the economic recovery is strong enough to generate sustained labor market improvement—I don’t think we have yet passed that test. The economy has not picked up forward momentum and a 2 percent growth rate—even if sustained—might not be sufficient to generate further improvement in labor market conditions.  Moreover, fiscal uncertainties loom very large right now as Congress considers the issues of funding the government and raising the debt limit ceiling.  Assuming no change in my assessment of the efficacy and costs associated with the purchase program, I’d like to see economic news that makes me more confident that we will see continued improvement in the labor market.  Then I would feel comfortable that the time had come to cut the pace of asset purchases.

In other words, never.

Next, despite last week's admission by Bullard that tapering is tightening, Dudley is still holding on to the old party line:

... any decision to cut the pace of asset purchases should not be taken as signaling an early exit from this period of unusually low short-term rates.  We have established a threshold of 6.5 percent for the unemployment rate as long as we do not expect inflation to exceed 2 ½ percent at a one-to-two year horizon and inflation expectations remain well-anchored.   It is likely to take a considerable amount of time to reach the 6.5 percent unemployment rate threshold.  Moreover, because the 6.5 percent unemployment rate is a threshold, and not a trigger, depending on the economic circumstances, we might wait a long time after we breach the threshold before we begin to raise our federal funds rate target.

 

The point I wish to emphasize is that any decisions on the pace of asset purchases (the rate at which we are adding accommodation) versus liftoff in terms of the federal funds rate (a tightening of monetary policy) should be viewed as largely independent of one another.   One does not foreshadow the other—certainly not in any mechanical way or with a definitive timeframe.   As Chairman Bernanke noted in last week’s press conference, our actions are data dependent and how the data will evolve is uncertain.

Nothing like losing even more confidence that the Fed is largely clueless about what is going on.

Finally, it is all Bush's fault. Or in this case that epic credit-bubble financial crisis that the Fed caused, the the Fed is now, five years later, still scrambling to fix...

... it is important to recognize that the financial crisis generated significant headwinds that are only slowly abating.  We must push against these headwinds forcefully to best achieve our objectives.  

... how? With an even greater credit bubble.