14/5/19: Monetary Policy at the edge of QE

My new column for the Cayman Financial Review on the current twists in global Monetary Policies is now available on line: https://www.caymanfinancialreview.com/2019/05/07/monetary-policy-at-the-edge-of-qe/.

10/1/19: QE or QT? Look at the markets for signals

With U.S. Fed entering the stage where the markets expectations for a pause in monetary tightening is running against the Fed statements on the matter, and the ambiguity of the Fed's forward guidance runs against the contradictory claims from the individual Fed policymakers, the real signals as to the Fed's actual decisions factors can be found in the historical data.

Here is the history of the monetary easing by the Fed, the ECB, the Bank of England and the BOJ since the start of the Global Financial Crisis in two charts:

Chart 1: looking at the timeline of various QE programs against the Fed's balancesheet and the St. Louis Fed Financial Stress Index:

There is a strong correlation between adverse changes in the financial stress index and the subsequent launches of new QE programs, globally.

Chart 2: looking at the timeline for QE programs and the evolution of S&P 500 index:

Once again, financial markets conditions strongly determine monetary authorities' responses.

Which brings us to the latest episode of increases in the financial stress, since the end of 3Q 2018 and the questions as to whether the Fed is nearing the point of inflection on its Quantitative Tightening  (QT) policy.

14/6/17: Unwinding the Mess: Fed's Road Map to QunE

As promised in the previous post, a quick update on Fed’s latest guidance regarding its plans to unwind the $4.5 trillion sized balance sheet, to the Quantitative un-Easing...

First, the size and the composition of the problem:

So, as noted in the post here: http://trueeconomics.blogspot.com/2017/06/13617-unwinding-mess-ecb-vs-fed.html, the Fed is aiming to gradually unwind the size of its assets exposures on both, the U.S. Treasuries and MBS (mortgage-backed securities). This is a tricky task, because simply dumping both asset classes into the markets (aka, selling them to investors) risks pushing yields on Government debt up and value of Government bonds down, as well as the value of MBS assets down. The problem with this is that all of these assets are systemically important to… err… systemically important financial institutions (banks, pension funds, investment funds and insurance companies).

Should yields on Government debt explode due to the Fed selling, the U.S. Government will simultaneously: 1) pay more on its debt; and 2) get less of rebates from the Fed (the returned payments on debt held by the Fed). This would be ugly. Uglier yet, the value of these bonds will fall, creating pressure on the assets valuations for assets held by banks, investment funds, insurance companies and pensions funds. In other words, these institutions will have to accumulate more assets to cover their capital cushions and/or sustain their funds valuations. Or they will have to reduce lending and provision of payouts.

Should MBS assets decline in value, there will be an assets write down for private sector financial institutions holding them. The result will be the same as above: less lending, more expensive credit and lower profit margins.

With this in mind, today’s Fed announcement is an interesting one. The FOMC “currently expects to begin implementing a balance sheet normalization program this year, provided that the economy evolves broadly as anticipated,” according to today’s statement. And the FOMC provides some guidance to this normalization program:

Instead of dumping assets into the market, the Fed will try to gradually shrink the balance sheet by ‘rolling off’ a fixed amount of assets every month. At the start, the Fed will ‘roll off’ $10 billion a month, split between $6 billion from Treasuries and $4 billion from MBS. Three months later, the numbers will rise to $20 billion per month: $12 billion for Treasuries and $8 billion for MBS. Subsequently, ‘roll-offs’ will rise $10 billion per month ever three months ($6 billion for Treasuries and $4 billion for MBS). The ‘roll-off’ will be capped once it reaches $30 billion for Treasuries and $20 billion for MBS.

This modestly-paced plan suggests that the ‘roll off’ will concentrate on non-replacement of maturing instruments, rather than on direct sales of existent instruments.

What we do not know: 1) when the ‘roll off’ process will begin, and 2) when will it stop (in other words, what is the target level of both assets on Fed’s balance sheet in the long run. But the rest is pretty much consistent with my view presented here: http://trueeconomics.blogspot.com/2017/06/13617-unwinding-mess-ecb-vs-fed.html.




PS: A neat summary of Fed decisions and votes here: http://fingfx.thomsonreuters.com/gfx/rngs/USA-FED/010030ZL253/

14/6/17: The Fed: Bravely Going Somewhere Amidst Rising Uncertainty

Predictably (in line with the median investors’ outlook) the Fed raised its base rate and provided more guidance on their plans to deleverage the Fed’s balance sheet (more on the latter in a subsequent post). The moves came against a revision of short term forecast for inflation (inflationary expectations moved down) and medium turn sustainable (or neutral) rate of unemployment (unemployment target moved down); both targets suggesting the Fed could have paused rate increase.

Rate hike was modest: the Federal Open Market Committee (FOMC) increased its benchmark target by a quarter point, so the new rate range will be 1 percent to 1.25 percent, against the previous 0.91 percent. This marks the third rate hike in 6 months and the Fed signalled that it is on track to hike rates again before the end of the year (with likely date for the next hike in September). The forecast for 2018 is for another 75 basis points rise in rates, unchanged on March forecast.

Interestingly, the Fed statement highlights that inflation (short term expectations) remains subdued. “Inflation on a 12-month basis is expected to remain somewhat below 2 percent in the near term but to stabilize around the committee’s 2 percent objective over the medium term,” the FOMC statement said. This changes the tack on previous months’ statements when the Fed described inflationary outlook as “broadly close” to target. Data released earlier today showed core consumer price inflation (ex-food and energy) slowed in May for the fourth straight month to 1.7 percent y-o-y. This is below the Fed target rate of 2 percent and suggests that monetary policy is currently running countercyclical to inflation. On expectations side, FOMC lowered its median forecast for inflation to 1.6 percent in 2017, from 1.9 percent forecast published in March. The FOMC left its forecasts for 2018 and 2019 unchanged at 2 percent.

The Fed, therefore, sees inflation slump to be temporary, which prompted U.S. 2 year yields to move sharply up:

Source: @Schuldensuehner

Which means that today’s hike was not about inflationary pressures, but rather unemployment, which dropped to a 16-year low at 4.3 percent in May.

As labour markets continue to overheat (we are now at 4.2 percent forecast 2017 unemployment and with over 1 million vacancies postings in excess of jobs seekers, suggesting a substantial and rising gap between the low quality of remaining skills on offer and the demand for higher skills), the Fed dropped its estimate of the neutral rate of unemployment (or, in common terms, the estimated minimum level of unemployment that can be sustained without a major uptick in wages inflation), from 4.7 percent in march to 4.6 percent today. At which point, it is worth noting the surreality of this number: the estimate has nothing to do with realistic balancing out of skills supply and demand, and is mechanically adjusted to match evolving balance between actual unemployment trends and inflation trends. In other words, the neutral rate of unemployment is Fed’s voodoo metric for justifying anything. How do I know this? Ok, consider the following forecasts & outlook figures from FOMC:

• 2017 GDP growth at 2.2% compared to 2.1%, unemployment rate at 4.2% compared to 4.5% prior, and core inflation at 2.0%, same as prior. So growth outlook is, basically, stable, but unemployment is dropping and inflation not budging. 
• 2018 GDP growth unchanged at 2.1%, inflation unchanged at 2.0%, and unemployment 4.2% vs 4.5% prior. So unemployment drops significantly, but GDP drops too and inflation stays put.
• 2019 GDP 1.9% vs 1.9% prior, unemployment 4.2% vs 4.5% prior and inflation 2.0% vs 2.0% prior. Same story as in 2018. 

In other words, it no longer matters what the Fed forecasts for growth and unemployment, inflation stays put; and it doesn’t matter what it forecast for growth and inflation, unemployment drops, and you can stop worrying about joint forecast for inflation and unemployment, growth remains remarkably stable. It’s the New Normal of Alan Greenspan Redux.


The FOMC next meets in six weeks, on July 25-26. Here is the dots chart of Fed’s expectations on benchmark rate compared to previous:

Source: https://www.bloomberg.com/graphics/fomc-dot-plot/

The key takeaway from all of this is that the Fed is currently at a crossroads: the uncertainty about key economic indicators remains elevated, as the Fed is compressing 2017-2018 guidance on rates. In other words, more certainty signalled by the Fed runs against more uncertainty signalled by the economy. Go figure…

10/6/17: Cart & Rails of the U.S. Monetary Policy

So, folks, what’s wrong with this picture, eh?

Let’s start thinking. The U.S. Treasury yields are underlying the global measure of inflation since the onset of the global ‘fake recovery’. Both have been and are still trending to the downside. Sounds plausible for a ‘hedge’ asset against global economic stagnation. And the U.S. Treasuries can be thought of as such, given the U.S. economy’s lead-timing for the global economy. Except for a couple of things:

1. U.S. Treasury is literally running out of money (by August, it will need to issue new paper to cover arising obligations and there is a pesky problem of debt ceiling looming again);
2. U.S. Fed is signalling two (or possibly three) hikes over the next 6 months and (even more importantly) no willingness to restart buying Treasuries again;
3. U.S. political risks are rising, not abating, and (equally important) these risks are now evolving faster than global geopolitical risks (the hedge’ is becoming less ‘safe’ than the risks it is supposed to hedge);
4. U.S. Fed is staring at the prospect of potential increase in decisions uncertainty as it is about to start welcoming new members ho will be replacing the tried-and-trusted QE-philes;
5. Meanwhile, the gap between the Fed policy’s long term objectives and the reality on the ground is growing: private debt is rising, financial assets valuations are spinning out of control and 

So as the U.S. 10-year paper is nearing yields of 2%, and as the premium on Treasuries relative to global inflation is widening once again, the U.S. Fed is facing a growing problem: tightening rates is necessary to restore U.S. dollar (and U.S. Treasuries) credibility as a global risk hedge (the key reason anyone wants to hold these assets), but raising rates is likely to take the wind out of the sails of the financial markets and the real economy. Absent that wind, the entire scheme of debt-fuelled growth and recovery is likely to collapse. 

Cart is flying one way. Rails are pointing the other. And no one is calling it a crash… yet…

24/2/17: Monetary Policy Outlook for 2017

My article for Manning Financial covering monetary policy outlook is out and can be viewed here: https://issuu.com/publicationire/docs/mf_february_2017__1_?e=16572344/44717793.

Alternatively, click on the following images to enlarge

21/4/16: Economic Outlook: Advanced Economies

My article on economic outlook forward for the Advanced Economies is now out at the Manning Financial quarterly: https://issuu.com/publicationire/docs/mf_magazine_april_2016_web_19042016?e=16572344/35062140.

28/8/15: Central Banks' Activism in a Chart

Having been out of contact due to work and summer break commitments, I will be updating the blog over the next few days with interesting bits of information that have been overlooked over the last 10 days or so. So stay tuned for numerous updates.

To start with, here is a picture of the Central Banks' monetary activism to-date:

Source: @Schuldensuehner 

The chart above sets 2005 = 1000 and indexes the uplift in Central Banks' balancesheets expansions: Fed almost x5.6 times; PBoC almost x6.4 times, ECB almost x2.3 times and heading toward x3.3 times under the ongoing QE, BoJ almost x2.1 times... not surprisingly, the old Fed 'put' is now pretty much every Central Bank's default option...

Much of this mountain of money printing has gone to grease the wheels of sovereign debt markets. Much of the resulting revaluation of financial assets is simply not sustainable under the premise of the Central Banks' 'puts' withdrawal (monetary tightening).

In simple terms, the ugly will get uglier and we have no idea if it will get any better thereafter.