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January 20, 2015

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Posted: 20 Jan 2015 12:06 AM PST

Fed Watch: Seconded

Posted: 19 Jan 2015 02:49 PM PST

Tim Duy:

Seconded, by Tim Duy: I see Jon Hilsenrath at the Wall Street Journal seconds my take from this morning:

Federal Reserve officials are on track to start raising short-term interest rates later this year, even though long-term rates are going in the other direction amid new investor worries about weak global growth, falling oil prices and slowing consumer price inflation.

This is generally consistent with my view. The Fed is likely reacting more slowly than market participants. Hilsenrath adds something I forgot to mention:

Central to their internal deliberations ahead of the March meeting is a debate about how low the jobless rate can fall before it stirs wage and inflation pressure. Fed officials estimate the "natural rate" of unemployment—meaning the rate below which wage pressures increase—is between 5.2% and 5.5%.

Mr. Rosengren said he was considering revising this estimate down because the jobless rate has fallen to near the 5.2%-5.5% range without triggering any sign of wage pressure. He said he suspected some of his Fed colleagues also were considering moving this estimate down. The lower the estimate goes, the more patient they might be before raising rates.

Just as I think it will be hard for the Fed to raise rates if the unemployment rate continues to fall while wage growth remains subdued, it will also be difficult to justify current estimates of the natural rate of unemployment under those circumstances. Still, I would caution that lowering the estimate of the natural rate would be, I think, an implicit rejection of the "underemployment hypothesis." It would be easier to adjust estimates of the natural rate downward if measures of underemployment were more consistent with their traditional relationships with unemployment. In other words, the natural rate may be consistent with subdued wage growth due to the existence of high levels of underemployment.

My opinion is that the global disinflationary environment would support low inflation at levels of unemployment below the Fed's current estimate of the natural rate, similar to the situation of the late 1990s.

Don't Blame Poor People for the Housing Crisis

Posted: 19 Jan 2015 11:11 AM PST

Tyler Cowen:

Were poor people to blame for the housing crisis?, by Tyler Cowen:
When we break out the volume of mortgage origination from 2002 to 2006 by income deciles across the US population, we see that the distribution of mortgage debt is concentrated in middle and high income borrowers, not the poor. Middle and high income borrowers also contributed most significantly to the increase in defaults after 2007.
...That is from the new NBER working paper by Adelino, Schoar, and Severino.  In other words, poor people (or various ethnic groups, in some accounts) were not primarily at fault for the wave of mortgage defaults precipitating the financial crisis.  The biggest problems came in zip codes where home prices were having large run-ups. ...

Fed Watch: Will The Fed Take a Dovish Turn Next Week?

Posted: 19 Jan 2015 08:38 AM PST

Tim Duy:

Will The Fed Take a Dovish Turn Next Week?, by Tim Duy: As it stands now, we are heading into the next FOMC meeting with the growing expectation that the Fed will take a dovish turn. Is it not obvious that global economic turmoil, collapsing oil prices, weak inflation, and a stronger dollar are clearly pointing to rapidly rising downside risks to the US economy? For financial market participants, they answer is a clear "yes." Expectations of the first rate hike have been pushed out to the end of this year, seemingly in complete defiance of Fed plans for policy normalization. The Fed may get there as well and abandon their carefully crafted mid-year plan, but I suspect they will not move quite as rapidly as financial market participants desire.
As a general rule, the Fed tends to act in a more deliberate fashion. To be sure, this was not evident during the crisis. Indeed, "panicky" might be a better adjective during that period. But note that in comparison to past bouts of tumolt on global markets, the US economy is in a much better place, with accelerating job growth when unemployment is already near traditional mandate-levels. From their point of view, this is a whole different world compared to that of the last round of Euro-induced crisis.
This take from Jonathan Spicer and Ann Saphir at Reuters probably saw less play than it deserved:
Tumbling oil prices have strengthened rather than weakened the Federal Reserve's resolve to start raising interest rates around midyear even as volatile markets and a softening U.S. inflation outlook made investors push back the timing of the "liftoff."
Kind of a "Fed is from Mars, markets are from Venus" situation. It is important to recognize that the Fed sees falling oil prices as a significant, unexpected development that represents the realization of an upside risk to their forecast. They are thinking of an outcome not unlike that revealed in the most recent Bloomberg/UMich read on consumer sentiment:

CONSEN011815

Through the roof, one might say. So at this point the Fed will view the external threats to the economy as just risks, but the very real move in oil is at a minimum adding upside risk to their forecasts or already pushing their forecasts to the upside. With regards to external threats, they probably think that more aggressive ECB action is in the wings to put their immediate fears to rest. And the downward push on inflation is, from their perspective, a transitory issue and therefore a non-issue.
Consider this also from the Reuters article:
Interviews with senior Fed officials and advisors suggest they remain confident the U.S. economy will be ready for a modest policy tightening in the June-September period, while any subsequent rate hikes will probably be slow and depend on how markets will behave.
in light of this from St. Louis Federal Reserve President James Bullard:
"The level of inflation is not so low that it can alone justify a policy rate of zero," Mr. Bullard said in material prepared for a speech in Chicago.
and this from San Fransisco Federal Reserve President John Williams:
Placing heavy emphasis on the date of liftoff "suggests that you don't have any other decisions to make," Williams said. "We want to be very confident that we're on the right path, that the data support that first move, but that first move on tightening is only one of many, many policy actions we'll need to do during the normalization. It's not the critical component."
and this from Federal Reserve Chair Janet Yellen:
So, I think you raise a very important point because, although there is a great deal of market focus on the timing of liftoff, what to matter in thinking about the stance of policy is what the entire path of interest rates will look like. And I really don't have much for you other than to say that they will be data dependent—that, over time, the stance of policy will be adjusted to try to keep the economy on a track where we see continuing progress toward achieving our goals of maximum employment and price stability.
My takeway is that the Fed sees the timing of the first rate hike as less important than everything that comes after that hike. This will leave them less eager to delay the hike. Given where the economy currently stands, I suspect they see little chance of damage from that first hike alone.
This is also interesting:
Some of those interviewed stressed that in the light of last year's strong jobs gains waiting until mid-year represented a cautious approach rather than an aggressive one, allowing the Fed to delay the rate liftoff if needed, particularly if inflation expectations turned sharply down.
The suggestion here is that at least some Fed officials view signaling a mid-year rate hike as the cautious approach because the data increasingly suggests to them that they should be moving sooner than later.
Bottom Line: I reiterate my view that despite the generally positive data flow, and the upward boost from oil, I don't see how they can justify raising rates without some reasonable acceleration in wage growth. That said, perhaps by my own argument above they can justify it on the basis of 25bp won't hurt anyone anyways. But my broader point is this: During normal times the Fed moves methodically if not ponderously. The current state of the economy gives them room to move as such. So I would not be surpised to see a fairly steady hand revealed in the next FOMC statement.

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