Economic conditions and the policy environment.s21.q4cdn.com/172394036/files/doc_events/Fed.pdf ·...

Economic conditions and the policy environment. National Investor Relations Institute November 12, 2015

These views do not necessarily reflect the views of the

Federal Reserve Bank of Atlanta or the Federal Reserve Board, though I think they should.

When in the hell is the FOMC going to raise interest rates? National Investor Relations Institute November 12, 2015

3

At the time of the September FOMC meeting six weeks ago, 13 of the 17 participants indicated that an “appropriate” monetary policy would allow for raising the policy interest rate target at least once before the end of this year.

Source: Federal Reserve, FOMC Summary of Economic Projections, Sept. 2015, and FRBA

4

Where, exactly, the equilibrium fed funds rate is (what eco-nerds like me call r-star), isn’t known. However, it is likely being suppressed, relative to normal times, by shifting demographics, slow productivity growth, and capital inflows from abroad.

Source: Federal Reserve, FOMC Summary of Economic Projections, Sept. 2015, and FRBA

Consensus longer-term equilibrium fed funds rate

Current equilibrium fed funds

rate?

5

The policy path (and a presumed “lift off” by year-end) was predicated on an economic outlook of growth modestly in excess of trend, and an associated employment growth that is sufficient to allow further absorption of unemployed labor.

Longer-run central tendency

Longer-run central tendency

Source: Federal Reserve, FOMC Summary of Economic Projections, Sept. 2015

6

Longer-term inflation target

Inflation will likely fall well short of the Committee’s longer-run target again this year, owing largely to “special factors”. But anchored inflation expectations and continued strength in output and jobs growth is expected to help direct the inflation trend back toward the inflation target in 2016.

Source: Federal Reserve, FOMC Summary of Economic Projections, Sept. 2015

7

On September 15, 2015 (latest information available), the Federal Reserve Board accepted the recommendations of three Federal Reserve Banks of maintain the current primary credit (discount) rate. Eight Reserve Banks wanted to increase the rate, one wanted a decrease.

Maintain the current primary credit rate of 75 basis points 1. Boston 2. New York 3. Chicago

Raise the primary credit rate to 1 percent 1. Philadelphia 2. Cleveland 3. Richmond 4. Atlanta 5. St. Louis 6. Kansas City 7. Dallas 8. San Francisco

Reduce the primary credit rate to 50 basis points 1. Minneapolis

Source: Federal Reserve

8

On September 15, 2015 (latest information available), the Federal Reserve Board accepted the recommendations of three Federal Reserve Banks of maintain the current primary credit (discount) rate. Eight Reserve Banks wanted to increase the rate, one wanted a decrease.

Maintain the current primary credit rate of 75 basis points 1. Boston 2. New York 3. Chicago

Raise the primary credit rate to 1 percent 1. Philadelphia 2. Cleveland 3. Richmond 4. Atlanta 5. St. Louis 6. Kansas City 7. Dallas 8. San Francisco

Reduce the primary credit rate to 50 basis points 1. Minneapolis

Source: Federal Reserve

While the pace of real GDP growth has recently slowed back to the FOMC’s estimate of long-run potential, consumer spending remains on a higher gear.

9

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

2010 2011 2012 2013 2014 2015

Real GDP Growth four-quarter percent change

Median longer-run projection of FOMC (2.0%)

Source: Bureau of Economic Analysis, FOMC Summary of Economic Projections, Sept. 2015

-0.5%

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

2010 2011 2012 2013 2014 2015

Real Personal Consumption Expenditure Growth

four-quarter percent change

through Q2 2015

Recovery average (2.2%)

The housing market continues to expand, with prices besting inflation and sales growth topping GDP growth by significant margins.

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-20%

-15%

-10%

-5%

0%

5%

10%

15%

20%

2001 2003 2005 2007 2009 2011 2013 2015

U.S. House Prices monthly index, year-over-year percent

change

Source: FHFA and S&P/Case-Shiller through August 2015,

0

200

400

600

800

1000

1200

1400

1600

0

1000

2000

3000

4000

5000

6000

7000

00 02 04 06 08 10 12 14

U.S. Single-Family Home Sales 12-month moving average, thousands,

SAAR

through August 2015

Existing (left axis):

4565

New (right axis):

499

11

If we just consider the domestic spending components, you can see the economy still looks quite strong. For comparison, the recovery average growth of final sales to domestic purchasers has been only 2.0%.

Source: Bureau of Economic Analysis

Contributions to Real GDP Growth GDP Growth Contribution

(annualized % contribution) Q2 (BEA 3rd

estimate) Q3 (BEA preliminary

estimate) Consumer spending 2.4 2.2

Business inv. spending 0.5 0.3

Residential Investment 0.3 0.2 Government 0.5 0.3

Growth of final sales to domestic purchasers 3.7 3.0

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“…This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.

Why the “delay”? Global conditions look unsettled and this tilts (slightly) the balance of risks to the economy away

from our objectives.

FOMC Statement, October 28th, 2015 (emphasis added)

13

A (possibly) precarious global situation was clearly being reflected in financial market volatility—even U.S. financial markets. While the VIX has ebbed, corporate bond spreads have widened, perhaps a symptom of shifting risk assessments.

1.0

1.5

2.0

2.5

3.0

3.5

4.0

10-11 10-12 10-13 10-14 10-15

Corporate Bond Spreads (Moody’s bond yield – 10 year Treasury yield)

Corp bond spread (Baa)Corp bond spread (Aaa)

through October 13, 2015 Source: Fed Board, Moody’s

0

10

20

30

40

50

60

06-11 06-12 06-13 06-14 06-15

CBOE Volatility Index: VIX index

through October 14, 2015 Source: CBOE

Debt ceiling, first episode with Greece

“Taper Tantrum”

China

Indeed, foreign growth slowed sharply in Q2. Most countries around the world are experiencing slower growth in 2015 than in 2014. Forecasts generally predict that foreign GDP will accelerate, but remain below trend over the medium term.

14

-10

-8

-6

-4

-2

0

2

4

6

8

07 08 09 10 11 12 13 14 15 16 17

Broad Real Foreign Gross Domestic Product Index (2005=100)

percent change, annualized

Source: Macroeconomic Advisers

Q2 2015

Forecast

1980-2007 average

-8

-6

-4

-2

0

2

4

6

8

10

Q2-2015 Real Foreign Gross Domestic Product

percent change, annualized

Sources: Haver Analytics, National Statistical Agencies, Federal Reserve Board

2014

And most foreign central banks are looking to add more stimulus to their economies, not less.

15

From the European Central Bank: "We will see whether a further stimulus is necessary. This is an open question." Mario Draghi From the Bank of Japan: “The Bank of Japan is likely to remain under pressure to expand its asset-buying or quantitative easing programme as slumping energy costs, weak exports and a fragile recovery in household spending kept inflation well short of its 2% target.” from the Guardian From the Bank of China: “On Friday the People’s Bank of China announced a quarter-point cut in benchmark interest rates, as well as a reduction in the amount of deposits banks were required to hold in reserve by 50 basis points, a week after official data showed the third-quarter growth of the world's second-biggest economy was at its slowest since the global financial crisis.” from CNBC From the Riksbank: “The Riksbank …said it would expand its bond buying program by 65 billion Swedish crowns ($7.65 billion) to a total of 200 billion crowns.” from CNBC

The incoming data have also shown a significant rise in business inventory holdings relative to sales. This could hint at a “backing up” of inventories directly, or indirectly, from slowing global growth.

16

1.001.051.101.151.201.251.301.35

Aug-10 Aug-11 Aug-12 Aug-13 Aug-14 Aug-15

Inventory to Sales Ratio: Merchant Wholesalers SA

1.201.221.241.261.281.301.321.341.36


Inventory to Sales Ratio: Manufacturing SA

1.15

1.20

1.25

1.30

1.35

1.40


Inventory to Sales Ratio: Total Business SA

Source: Census Bureau data through August 2015

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Contributions to Real GDP Growth GDP Growth Contribution

(annualized % contribution) Q2 (BEA 3rd

estimate) Q3 (BEA preliminary

estimate) Consumer spending 2.4 2.2

Business inv. spending 0.5 0.3

Residential Investment 0.3 0.2 Government 0.5 0.3

Growth of final sales to domestic purchasers 3.7 3.0

Exports 0.6 0.2 Imports -0.5 -0.3 Change in Net Exports (billions $2009) 0.2 -0.1

Change in inventory investment (billions $2009)

0.0 -1.4

Annualized Real GDP Growth 3.9 1.5

But net exports and inventories weighed down Q3 growth. And net exports may remain a headwind for many more quarters.

Source: Bureau of Economic Analysis; FRB Atlanta; Macroeconomic Advisers

Adding to the uncertainty regarding the trajectory of the economy, retail sales stepped down a bit in September and consumer confidence has also slipped in recent months. Weakening confidence is bad for sales.

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0%

1%

2%

3%

4%

5%

6%

7%

8%

09-12 09-13 09-14 09-15

Nominal “Core” Retail Sales* year-over-year percent change

*Excludes sales of autos, building materials, and at gasoline stations

Source: Census Bureau through September 2015

65

70

75

80

85

90

95

100

105

09-12 09-13 09-14 09-15

University of Michigan Consumer Sentiment Index

Q1 1966=100

Source: University of Michigan Survey of Consumers through October 2015

annualized percentage change Retail Sales “Core” Sales

September 2015 1.3 0.9

Past 3 months 3.6 3.2



0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

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probability Probability of a “Lift-off” for the Fed Funds Rate by December

Source: FRBA (based on eurodollar futures contracts)

Just prior to the September FOMC meeting, the probability that the FOMC would raise the fed funds rate off zero BY DECEMBER was about 75 percent.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

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September FOMC statement

Yellen: “Most FOMC participants,

including myself,

currently anticipate…an initial increase

in the federal funds rate later

this year.”

Following the FOMC statement for September, markets lowered the probability of liftoff this year to about 50/50. Chair Yellen’s statement that she still concurred with the view that it would be appropriate to raise the fed funds rate by year-end, given the current economic outlook, didn’t appear to change expectations very much.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

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September jobs report


including myself,



this year.”

But the September jobs report did. Slower-than-expected jobs growth in August and September pushed rate hike likelihoods sharply lower.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

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Governor Brainard: “With equilibrium real interest rates likely to

remain low for some time and policy options that are more limited if conditions deteriorate than if they

accelerate, risk-management

considerations counsel a stance of waiting to see if

the risks to the outlook diminish.

Governor Tarullo: “I wouldn’t expect

it would be appropriate to

raise rates this year.”


including myself,



this year.”

Governor Brainard’s

“Policy Bomb.”

Following statements from two Fed Governors, the likelihood of an increase in the fed funds rate by December had fallen to 25%.

23

Dissents at an FOMC meeting are more common than not. However, in the post Volcker era at the Fed, dissents by Governors have been rare.

Number of dissents

24

“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress--both realized and expected--toward its objectives…”

While the FOMC declined to move on rates at their October meeting, the FOMC statement seemed to suggest that the time for raising rates may be getting close…


0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

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Following the October FOMC statement, probabilities of a December rate increase picked back up to nearly a 50/50 chance.





Governor Brainard: “With equilibrium real interest rates likely to

remain low for some time and policy options that are more limited if conditions deteriorate than if they

accelerate, risk-management

considerations counsel a stance of waiting to see if

the risks to the outlook diminish.





including myself,



this year.”


“Policy Bomb.”

October FOMC statement

26

But it was the view of the committee that it would need to see the labor market continuing to improve and signs that would give confidence that inflation was likely to move back in the direction of 2 percent for a lift-off decision.

“…The Committee anticipates that it will be appropriate to raise the target range for the federal funds rate when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term…”


And last Friday, we got a good confirmation on jobs. Jobs growth surged, reversing a slowing trend over the previous two months. Jobs growth of 112,000 per month is about the threshold needed to continue to make progress in the labor market.

27

0

50

100

150

200

250

300

350

400

450

11 12 13 14 15

12-month average

Monthly change

Source: Bureau of Labor Statistics through September 2015

Payroll Employment Changes thousands of jobs, SA

112,000 threshold (avg. monthly change in payrolls necessary

to keep pace with labor force growth)

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

28




Sep jobs

report





including myself,



this year.”


“Policy Bomb.”

October FOMC statement

After the October jobs number, the likelihood that the Fed will begin raising interest rates in December went back up to about a 3/4 chance (at least according to euro-dollar futures).

Oct Jobs

report

29

4

5

6

7

8

9

10

11 12 13 14 15

Unemployment Rate percent

Source: Bureau of Labor Statistics; FOMC Projections data through October 2015

At 5.0 percent, the unemployment rate is now solidly in the range of FOMC participants’ estimates of “normal.” It may begin to press on full capacity in the labor market.

Central tendency of FOMC participants’ long-run unemployment rate estimate

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1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

4.5%

5.0%

07 08 09 10 11 12 13 14 15

Wage Measures year-over-year change, SA

Average Hourly Earnings: Total Private Industries (SA, $/Hour) % Change - Yearto Year

Source: Bureau of Labor Statistics; FRBA ECI data through Q2 2015, AHE data through September 2015, FRBA series through June 2015

While in some models, slack appears to be having only a modest role in holding down the inflation trend, most measures of wage growth remain a percentage point under pre-recession levels. These data hint at more substantial downward cost pressures coming from “slack” resources.

31

Whether measured by headline or core, inflation is running well below the FOMC’s objective.

0.0

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

10 11 12 13 14 15

PCE Price Index year-over-year percent change, monthly

PCECore PCE

Sources: Bureau of Economic Analysis; Federal Reserve Bank of Dallas through September 2015

FOMC Inflation Objective

(annualized % change) Overall Core Dallas

trim

September 2015 -1.0 1.8 1.7

Past 3 months 0.0 1.3 1.5

Past 6 months 1.2 1.5 1.9

Past 12 months 0.2 1.3 1.7

The rising dollar has clearly had a broad, downward influence on import prices. The question of how much of a “disinflationary” import prices are having on domestic inflation dynamics is an open question.

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114

115

116

117

118

119

120

121

122

08-10 08-11 08-12 08-13 08-14 08-15

Import Price Index: All imports excluding fuels NSA, 2000=100

percent change 6-month change

12-month change

24-month change

Capital goods -2.4 -2.3 -1.1

Automotive vehicles, parts and engines -0.5 -1.4 -1.1

Consumer Goods, excluding automotives -0.7 -1.1 -0.1

Industrial Supplies and Materials -8.3 -30.2 -18.4

Source: Bureau of Labor Statistics data through September 2015

33

Can we decompose the recent inflation trends by source of the “disinflation”? We can try. A model based approach (Federal Reserve Board) suggest nearly all of the recent slowing in the inflation trend is due to oil and import prices. This suggests that once these forces dissipate the inflation trend will move

back toward 2 percent. Of course, models have been wrong in the past…

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1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

90 92 94 96 98 00 02 04 06 08 10 12 14

Survey of Professional Forecasters (10-year average)

TIPS: 5-year, 5-year forward

Survey data suggest inflation expectations are holding steady. But readings from the U.S. treasury market suggest that inflation compensation is falling—and sharply.

Measures of long-run inflation expectations percent

Source University of Michigan’s Survey of Consumers; FRB Philly’s Survey of Professional Forecasters data through Q3 2015

Adding up the arguments:

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Arguments for raising Arguments for holding 1. We’re still too far from full employment. 1. We’re approaching full employment—

and policy reacts with a lag.


36



2. The global situation is deteriorating and there are signs it may be spilling over to the U.S. economy.

2. Domestic demand is running strong.


37





3. Estimates that “explain” inflation behavior are uncertain. And inflation forecasts have consistently been too optimistic.

3. Inflation is reflecting transitory events. When these pass, a stronger inflation trend will be revealed.


38





4. Asset valuations including housing don’t appear to be out of line with normal times.

4. The zero-rate environment is abnormal and fueling troubling excess in housing and other asset markets.




39





4. Asset valuations including housing don’t appear to be out of line with normal times.

4. The zero-rate environment is abnormal and fueling troubling excess in housing and other asset markets.



5. No one is quite sure where the equilibrium rate is right now, and under current conditions our rates may not be as low as we think.

5. Interest rates are abnormally low and these aren’t abnormal times. Besides, the rise in rates will be very gradual.

According to the FOMC’s current normalization plan, the workhorse tool for “pulling” the fed funds rate higher will be the interest paid on excess reserves (IOER) with additional support via ON RRP sales. .

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0

0.5

1

1.5

2

2.5

Sep-14 Mar-15 Sep-15 Mar-16 Sep-16

Policy Rates: Hypothetical Path Illustration

percent

Overnight Reverse Repo Rate (ON RRP) - The implied interest rate on ON RRPs conducted by the Federal Reserve Bank of New York on behalf of the FOMC is expected to define the lower end of the range of the FOMC’s targeted fed funds range.

Interest on Excess Reserves (IOER) rate - The interest rate the Federal Reserve pays depositors on their excess reserve balances. This interest rate is determined by a vote of the Governors of the Federal Reserve and is expected to define the upper end of the range of the FOMC’s targeted fed funds range.

Fed Funds Rate - The benchmark policy interest rate target of the FOMC, this is the overnight borrowing rate for reserves between financial institutions.

Source: FRBA Calculations

Hypothetical liftoff September 2015

IOER

fed funds rate target range (25 bps)

ON RRP Rate Primary credit rate ?

When in the hell is the FOMC going to raise interest rates? National Investor Relations Institute November 12, 2015

Economic conditions and the policy environment.s21.q4cdn.com/172394036/files/doc_events/Fed.pdf ·...

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