Are the Fed’s interest rate projections credible?

At the FOMC meeting on September 19 and 20, members charted the central bank’s so-called dot plot of expected rates for the years out to 2020, involving one interest rate hike in 2017, three in 2018, two in 2019 and only one in 2020, leading to an end figure of 2.875% vs. 1.125% currently. These figures published by the Fed are generally extreme, as the US central bank endeavors to influence investors’ expectations to suit its own narrative. Continue reading

The Fed normalizes its monetary policy but is not optimistic

As expected, the Federal Reserve has decided to start the process of reducing the size of its balance sheet. It will start next month in October. Details of the operation were presented in June and are available on a post send earlier today.

During her press conference, Janet Yellen has clearly announced the hierarchy between the two instruments the Fed can use to manage its monetary policy. The main instrument remains the fed fund interest rate. In “normal” time, this is the instrument that must be used by the FOMC to manage its monetary policy. The purchases of assets could become again an instrument for the Fed if the situation is exceptional. The interest rate is the rule and the assets’ purchase is the exception. But it was a relevant question as the current level of the fed fund is too low to have a strong impact on the economic activity in the case of a negative shock. A quantitative adjustment could be necessary. Janet Yellen sees a kind of complementarity between the two and the two instruments must remain in the central banker toolbox.  Continue reading

The US Federal Reserve in unknown territory

Written with Aline Goupil-Raguénès

During today’s meeting, the probability is high that the Federal Reserve will decide to reduce the size of its balance sheet.
This latter started to increase at the end of 2008, first when the Fed was a provider of liquidity to the banking sector, and second when the US central bank started to purchase assets on a large scale. Few figures will give the scale of the transformation; in 2007 on average the size of the balance sheet was USD 830bn, it is now close to USD 4 500bn. As percentage of GDP the change is impressive from 5.7% on average in 2007 to 23% during the second quarter of this year.
Many questions are associated with this new step in the normalization of the US monetary policy. That’s the reason of this post and of the attached detailed document which is more technical but also more precise on the way it will work. Continue reading

Wind will blow strongly on the Fed

Stan Fisher the Fed’s vice president has decided to resign at mid-October for personal reasons. This will dramatically changed the internal equilibrium of the Fed’s board. Until now, three seats were vacant but there were 4 members appointed by Barack Obama. Their mandates are going at least beyond 2020 for all of them. The numerical advantage could lead to a statu quo and the possibility for Janet Yellen to remain president of the board.
With Fischer’s resignation the balance changes with now 4 seats that are unoccupied. On these 4, one has already been appointed by Donald Trump. Randal Quarles a private banker will replace Daniel Tarullo but he has yet to be confirmed by the Congress.
Who will be the next three? And who will be the next Fed’s president? Before Fischer’s resignation it could have been Yellen but we cannot expect this conclusion now.

4 types of risks
1 – If the Fed’s members appointments mimic what’s happening in the current Trump administration we can expect that many of these vacant seats will remain vacant. In many ministers, many jobs with high responsibility have not been filled yet. It would be problematic for the monetary policy management and the credibility of the US central bank.
2 – Will the next president be an economist as it is the rule? Jimmy Carter in 1978 named a non economist and it was a nightmare.
3 – There is not a lot of talented economists who claim for the job. It’s annoying for the quality of the board, the monetary policy management and the prospects for the US economy.
4 – With this new equilibrium and a Congress with a republican majority there is a risk on the independence of the Fed. Many reports from the republican side have asked for a Fed following a monetary policy rule (a Taylor rule type). Following such a rule would limit the capacity of judgement of the US central bank and its independence as it will have to follow the rule.

Fischer’s resignation can be a game changer on monetary policy at a moment where the US economic policy is just monetary policy.

Fed: The announced normalization

The Fed main interest rate was increased by 25bp at the June meeting of the FOMC. It will now be in the corridor [1; 1.25%]. This is the fourth hike since December 2015 (start of the tightening cycle).
The impact of this monetary policy change has been very limited. The Fed’s communication strategy is to clearly say in advance what it will do. The Fed doesn’t want to create surprises to investors. Therefore investors can adapt their expectations and their portfolios to the new monetary policy stance. The impact of the measure when it is announced is null.
This is interesting notably on emerging markets. In the past, the Fed’s tightening cycle had a strong impact on them as capital flows were back to the US at the expense of emerging countries. Investors were surprised by the Fed’s move. That’s what economists call a sudden stop. Here, no one is surprised so there are no reversal in flows and emerging markets remain strong.

The Fed considers that the economy is now close to full employment (employment rate is 4.3%) and the inflation is close to its 2% target. Therefore it can be rational to increase rates. But as mentioned earlier, the Fed doesn’t want to create too much volatility and to create a persistent shock on the economy. That’s why its measures are announced loudly in advance.  Continue reading