Monday, September 28, 2009

The Fed draining reserves?

Prof. Jim Hamilton at Econbrowser (thanks Mark Thoma for the link) addresses one of the Fed’s standard methods of draining liquidity from the banking system: reverse repurchase agreements. Basically, the Fed will transfer some of its assets to the banking system via short-term loans taken out with its Primary Dealers, presumably offering standard (Treasuries) and less standard (MBS or agency bonds) assets as collateral.

Reverse repurchase agreements simply slosh around the assets (MBS, agencies, and Treasuries) between the Fed and the Primary Dealers, rather than removing the assets from the Fed’s balance sheet permanently. Eventually, though, the Fed must sell the securities outright onto the open market – we are far, far from that!

This is all hot air for now. How can the Fed soak up the expansionary liquidity, let alone unwind $1 trillion in assets, when the banking system is still shedding pounds?

The Fed is considering another route, too: conducting the same repurchase agreements with the money-market mutual fund industry in tandem. An excerpt from the FT:
The Federal Reserve is looking to team up with the money-market mutual fund industry as part of its strategy to ensure that its unconventional policies to stimulate the economy do not produce a bout of post-crisis inflation.

The central bank envisages eventually draining liquidity from the financial system by engaging in trades called “reverse repos” with the deep-pocketed money-market funds. In these, the Fed would pledge mortgage-backed securities and Treasuries acquired during the crisis as collateral for short-term loans from the funds.

The obvious counterparties for reverse repo deals are the Wall Street primary dealers. However, the Fed thinks they would only have balance sheet capacity to refinance about $100bn of assets. By contrast, the money-market funds have $2,500bn in assets, which means they could plausibly refinance as much as $500bn in Fed assets. Officials think there would be appetite on the part of the funds, which are under pressure from regulators and investors to stick to low-risk liquid investments.
The Fed is solely attempting to assuage inflation angst at this time; it’s still very premature to talk about an exit of expansionary policies when credit markets still crimp the stimulus that the Fed so desperately wants to get into the open market (much of the base, roughly $855 billion on September 23, 2009 and up from $2 billion in August 2008, remains on balance with the Fed in the form of “excess reserves). Just look at the crunch in the consumer credit space (chart to left).

As Prof. Hamilton suggests, the mechanisms of the reverse repos should successfully sterilize the base before it starts to become inflationary (with either the Primary Dealers and/or the Mutual Funds industry). However, one of the programs through which the Fed utilized previously to sterilize its liquidity, and to which Prof. Hamilton refers, – the Supplementary Financing Program – is unlikely to be an avenue for removing liquidity.

In fact, it’s quite the opposite. The Treasury already announced its imminent plan to liquidate the bulk of its $200 billion account with the Fed. There’s another $200 billion in excess reserves with which the Fed must contend (see my previous post here).

It’s easy to get the liquidity into the financial system. But getting it out without collapsing the economy or allowing inflation pressures to build? Well, that’s a different story.

Rebecca Wilder

Friday, September 25, 2009

The Fed's moving target: NAIRU

This is the article that I wrote on Angry Bear today.

Neal Soss and Henry Mo at Credit Suisse published a very interesting article, "Where is full employment in a more volatile macroeconomy?", where they argue that the natural (long run) rate of unemployment may be shifting (they do this by showing that the Beveridge curve, which plots the the job vacancy rate against the unemployment rate, is shifting upward). I cannot provide a link, but here are their conclusions pertaining to monetary policy:
In the case of rising NAIRU [RW: this is the rate of unemployment that does not grow inflation, often called the long-run rate] and higher economic volatility, the monetary policy implication is complicated.

On the one hand, a higher NAIRU suggests that it would require a strong and prolonged recovery for the unemployment rate to return to the level attained in the past two decades. This scenario argues for a long period of low interest rates, because the economy’s structure will make it harder to get unemployment back to the low levels of recent business expansions.

On the other hand, a higher NAIRU suggests higher inflation pressure, as the output gap is smaller than otherwise would be the case. In other words, the Fed would have to normalize its policy stance sooner than would have been the case warranted by a stable NAIRU.

The burden of this is likely to be several years of quite low short-term interest rates by any modern standard other than the zero-ish levels of today. Even if the NAIRU is deteriorating, it is likely to be several years before the economy generates enough of a drop in unemployment to get to the new NAIRU, presumably above the levels of the last 20 years but surely below the current 9.7% unemployment rate. Between now and then, high unemployment is likely to remain the focus of policy attention. Labor market policies, such as job retraining for the unemployed, to improve the inflation unemployment trade-off, would make the central bank’s job a lot easier as that longer-run unfolds.
Basically, if the long-run level of unemployment, which the Fed targets implicitly under their dual mandate (maximum sustainable employment and stable prices), is changing then the Fed’s job becomes that much more difficult. Policy is only as good as the model’s calibration: they need to confidently estimate and target a level of employment that may be very much in flux. A simple Taylor Rule estimation illustrates this point.

Note: The Taylor Rule is a policy rule that relates the federal funds target to inflation and the output gap: roughly speaking, as inflation rises relative to the output gap, the Fed should tighten (raise its target); and as the output gap rises relative to inflation, then Fed should ease (lower its target). I estimate the relationship, and you can view my data here, and Wells Fargo's forecast here.

On one hand, the CBO projects that NAIRU is 4.8%. In this case, the Taylor Rule policy drops the fed funds target to -4.6% by the end of the year. Put it this way: the output gap is so big that policy is very, very aggressive but bound by zero.

On the other hand, if NAIRU has shifted to something more like 6% - this is roughly its level in the 1980’s - then the policy prescription is less aggressive. The output gap remains wide, but the implied target rises to -3% rather than almost -5% - still negative, but suggestive of a more benign policy strategy. Inflation pressures would start to build earlier than under the 4.8% case.

This complexity has been documented by the Fed in the minutes of their August 2009 meeting:
Though recent data indicated that the pace at which employment was declining had slowed appreciably, job losses remained sizable. Moreover, long-term unemployment and permanent separations continued to rise, suggesting possible problems of skill loss and a need for labor reallocation that could slow recovery in employment as the economy begins to expand.
Note: this not the same thing as a jobless recovery – the unemployment rate may very well fall with economic growth (no jobless recovery), but then settle at a structurally higher level.

Rebecca Wilder

P.S. I will not be able to respond to comments until tomorrow.

Thursday, September 24, 2009

Unemployment insurance rate: still a leading indicator of the national unemployment rate

Every morning I give my economic spiel to the bond group – this morning, the Department of Labor reported that the number of weekly initial claimants fell 21k to 530k, dragging the 4-wk moving average down 11k to 553.5k. Also in the release, the insured unemployment rate (number of employees claiming unemployment insurance divided by the stock of employees that qualify for unemployment insurance under the regular 26-week (generally) state programs), which is seen as a leading indicator of the unemployment rate, dipped 0.1% to 4.6% in the week ending September 12. A downward trend here normally leads the national unemployment rate.

But in times like these, when the actual number of insured rests around 9 million and exceeds the 6.1 million in the regular state programs, does the insured unemployment rate still indicate trends in the national unemployment rate? (The chart to the left illustrates the total unemployed claiming insurance benefits under the regular state programs (the calculation of the aforementioned unemployment insurance rate) + claimants under the emergency programs, EUC 2008 and Extended Benefits (see the release here).)

It looks like the relationship remains rather strong. The chart below illustrates the estimated relationship between the monthly average of the insured unemployment rate and the national unemployment rate (currently 9.7%) since 1981.

The simple equation has an R2 = 0.858, which is respectable. And the most recent data points, July and August in green and red, respectively, rest very close to the fitted line – August is right on the fitted line. If the insured unemployment rate continues to decline, the relationship suggests that so, too, will the unemployment rate.

However, the initial claims numbers will be dropping as well, and initial claims are the most current information out there (besides the daily Treasury receipts). Initial claims remain well above any level that would suggest a decline in the unemployment rate (around 350k-400k).

I don't believe that the economy will see a jobless recovery - i.e., the job loss that occurred for almost two years following the end of the 2001 recession (November 2001).

The 4-wk average to date is starting to look that way, but there is just so much spare capacity - August 2009 capacity utilization rate was just 69.6% compared to 73.5% in November 2001. I just don't see why a firm would opt to buy new capital before it uses its excess capacity - that means hiring workers.

Rebecca Wilder

Tuesday, September 22, 2009

Central bank rates one year from now...FF up 52 bps

The core inflation rate has dropped to 1.4%, while the unemployment rate surged to date. And barring some unforeseen and positive economic surprise, like renewed confidence driving consumer spending more quickly than anticipated, these variables that define the Fed's dual mandate are likely to remain outside the Fed's comfort zone into next year. Therefore, policy is likely to be quite expansionary in the foreseeable future (which in forecasting terms, that is 2010). But how far into the future; and what will be its exit strategy?

I just wanted to chime in on this issue of Fed exit strategy, specifically with rate hikes (or, as some of you will properly identify, target rate hikes). The Fed has a ton of policy to unwind, over a $trillion in direct asset purchase: >$800 in billion MBS, soon to be $300 billion in Treasuries, and soon to be $200 billion in agency debt. Furthermore, the Fed dropped its target rate (the federal funds rate, ff rate) to practically 0%. Therefore, there are several permutations of exit strategy to consider. Here are the main ones:
  1. The Fed unwinds the assets first, and then raises its target rate
  2. The Fed unwinds its assets after raising its target rate
  3. The Fed mixes exits: unwinding assets while contemporaneously raising its target rate
Timing is key here, and NOBODY expects the Fed to raise tomorrow. The Fed will monitor financial markets and the economy, and decide which action is appropriate. But given the obvious interdependence between financial markets and the economy, my bet's on a contemporaneous rate hike and asset sell-off. But let's be real, even the Fed hasn't mapped out its exit strategy in full.

The MBS market is tricky. Unless the housing market is plugging away, it will be difficult for the Fed to inundate the MBS market with its very huge supply of MBS (11% of the market as of June 2009, and counting). Therefore, it is likely that the Fed exits in a more weighted way: more quickly selling off assets, but also raising its target rate.

According to Morgan Stanley and the overnight indexed swap curve, the Fed’s target rate is expected to be just 52.9 bps higher than it is today (see cum in the chart below) in June 2010, or about 0.75%.

Given that consensus expects the unemployment rate to be in the 9%-10% range by then, I’d say that 75 bps is more of an upper bound. Unless inflation gets a push forward – at the core level, this is very unlikely given the long lags in price fluctuations – the economy will be just too weak. The decline in all measures of prices (including wages) will keep inflation very much in check, with some upside risk on the back of emerging market growth and energy price gains.

So there you have it. Is the market correct? 75 bps next year? That's still a lot of stimulus left in the system.

Rebecca Wilder

Sunday, September 20, 2009

Links for Sunday (September 20, 2009)

I wrote this article over at Angry Bear and know that some of you all might be interested in the read: Policy and housing: someone's gotta give.

Also, please visit David Beckworth's blog, Macro and Other Market Musings. He writes a really nice article on the equation of exchange - I plan to comment on this, but you all should read it as a heads up!

Finally, did you know that "UFO sightings have reached record levels in 2009"? The Telegraph ties this to the surging unemployment rate.

Rebecca Wilder

Saturday, September 19, 2009

Thursday, September 17, 2009

Flow of funds: not a shock, but interesting nevertheless

I always get excited when the Federal Reserve releases its quarterly Flow of Funds Tables. I will keep this short, as it is 9:30pm and my husband is about to scream.

First things first: household net worth is stable. A very good representation of the "wealth effect" is seen in the ratio of household net worth to personal disposable income (income net of taxes). This ratio is negatively correlated with the saving rate: as consumer wealth rises relative to income, the incentive to save (spend more now) falls.

As the chart illustrates, the ratio of net worth to disposable income rested quietly between 4 and a little over 5 spanning much of the measured series (1951, not shown, to about 1996); it now sits inside that band, 4.87 in Q2 2009. According to this relationship, spending and saving should stabilize, with households paying down debt and increasing consumption accordingly with income generation.

The point of income generation is not the topic here. But since wage growth is down to record lows (see Mark Thoma's post here), it seems that there is no way to go but up once the labor market turns around.

Households are taking a beating in credit markets, finding return only in the riskier equity markets.

And finally, the federal government owned nearly 15% of all securities in the GSE-backed MBS market. The Fed accumulated 11% of that!

It's going to take a much healthier economy than this one to withstand an unwinding of the Fed's balance sheet. Like I said, not surprising but interesting nevertheless.

Rebecca Wilder

Wednesday, September 16, 2009

$1 trillion in excess reserves on the horizon!

The Fed's effort to sterilize its expansionary policies is going bye bye. According to the Treasury:
"Treasury currently anticipates that the balance in the Treasury's Supplementary Financing Account will decrease in the coming weeks to $15 billion, as outstanding Supplementary Financing Program bills mature and are not rolled over. This action is being taken to preserve flexibility in the conduct of debt management policy."
On balance September 9, the Fed holds $199,932 million in liabilities to the Treasury under the Supplementary Financing Account, of which $199,932 - $15,000 = $184,932 million will be paid to the Treasury. How much do you wanna bet that the liquidation of the Treasury's account ends up in excess reserves, increasing the balance from $823,201 million on September 9 to $1,008,133 million (yup, that's $trillions).

Rebecca Wilder

Tuesday, September 15, 2009

Consumer spending on the mend?

There is some evidence out there that consumer spending has dropped so low, that with confidence anew (see national Consumer Confidence and Sentiment surveys), consumers are taking baby steps back into the spending picture. According to Gallup, consumers spent and average $66/day on 9/13/09, up from $59/day at the end of August.

The chart illustrates the 14-day moving average of daily expenditures on everything except housing, bills, and car purchase, as surveyed by Gallup. I guess that they view this to be discretionary spending, although autos could be viewed as such. There are a couple of things to note here. First, the trend has been down - falling from around $100/day in the first half of 2008 to below $60/day in the first half of 2009. To be sure, growth rates can be big off of lows - returning to $100/day could mean a >50% surge in spending in the national accounts (obviously, this is a gross over-simplification). Second, the series is not likely seasonally adjusted, so the difference could simply be cost of energy (depending on what is classified as "normal household bills").

However, if consumer discretionary spending is forming a bottom, which another private survey confirms, the employment picture is key. Spending fueled by debt is likely dead for a while at least, and good old income growth is the only means by which consumers can increase spending (i.e., satisfy pent-up demand) while contemporaneously save a larger share of income (4.2% in July). But credit will flow again to those worthy borrowers that demand as such - it's just back to basics in banking, with due diligence on lending and underwriting standards.

Rebecca Wilder

Friday, September 11, 2009

What would Friedman say?

I have argued that the ECB didn't do enough to support the Eurozone (a few examples here, here, here) - further monetary policy was warranted. As the financial crisis abates and key economies mend, I want to revisit this issue just one more time. Now, it seems that the Fed could beef up its lending, as the money supply growth rate turns red.

To be fair, the ECB's balance sheet is large relative to the size of the Eurozone, but nevertheless, its monetary support has relatively small compared to the BoE and the Fed (they did provide credit support by purchasing covered bonds, but nothing of the quantitative easing flare like in the US and the UK).

The chart illustrates the size of the central bank balance sheet as a % of GDP for the Federal Reserve (Fed), the Bank of England (BoE), and the European Central Bank (ECB) as of September 2, 2009. Relative to the size of its economy, the Fed and the BoE engaged in large expansionary policies by growing their balance sheets in order to stablilize the financial system. On the other hand, the ECB, while dropping its rate to 1% and supporting the credit system through its covered bond purchase program, did not.

However, credit is still quite restricted (see previous post on the US credit crunch) - so much so that the 3-month annualized growth rate of the money supply - M4 in the UK, M3 in the Eurozone, and M2 in the US - is low, even negative.

I wonder what Friedman would say....more deflation is on the way? It's way too early to turn off the money valve - the lack of credit flow precludes much money growth right now. Just look at how weak was the consumer credit report.

Rebecca Wilder

Wednesday, September 9, 2009

Consumer credit will come back when the labor market turns

The Federal Reserve Board released its consumer credit for the month of July:
Consumer credit decreased at an annual rate of 10-1/2 percent in July 2009. Revolving credit decreased at an annual rate of 8 percent, and nonrevolving credit decreased at an annual rate of 11-3/4 percent.
This report describes the full non real estate consumer lending space – securitized, loans from finance companies, government lending, as well as commercial bank, credit union, and saving institutions lending - it's much bigger than the Fed's commercial bank weekly lending series. This month, the broad drop in credit was a shock to the downside, but not unexpected given that the unemployment rate is more than double that which the CBO deems to be the long-run level (see the NAIRU level of unemployment, 4.8%).

On a seasonally adjusted basis, total consumer credit tumbled at a 7.1% 3-month annualized pace (a little more smoothed than the monthly series).

The chart illustrates the 3-month annualized growth rate of consumer credit (total = revolving + non-revolving) and the unemployment rate. The negative correlation is very strong during periods when the unemployment rate is rising quickly - this time around is no exception.

Why is consumer credit falling? Is it due to tight lending standards? Or rather is it precipitously falling consumers demand for credit? That information is not available in the data, however, the Federal Reserve’s Senior Loan Officer Survey an increasing share of banks reported falling demand for consumer credit in the second quarter of 2009. Standards are still tightening, but a falling share of banks report having done so.

My bet's that the demand-side is driving the credit at this point in the cycle. But I have also argued that the revolving credit lines (i.e., credit cards) took a hit in response to recent credit card regulation. As an anecdote, I saw two of my cards canceled for inactivity, and others have seen their credit limits slashed. Would I have used those cards had they not been canceled? Point: in some cases, consumers are being forced to reduce revolving credit.

It's all about the labor market and renewed confidence. As the domestic stimulus further underpins the economy, and as the US reaps the benefits of big, big global stimulus, confidence will, more likely than not, re-emerge.

Rebecca Wilder

Tuesday, September 8, 2009

New rankings on country competitiveness: Singapore is number 3!

The World Economic Forum released its Global Competitiveness Report for 133 countries. The top headline: US is out, Switzerland is in (number 1, that is); Singapore grabbed third place, pushing out Denmark.

The chart illustrates the change in rankings across the top 30 competitive economies in 2009-2010. Countries below the dotted line increased their ranking from last year, and countries above decreased their ranking. As you can see, the majority of (developed) economies dropped in their competitiveness rankings. The world banking crisis and financial institution regulation (whose epicenter was the US) were clearly major factors.

Here are some bullet points from the report (in the highlights report) on the top three competitive countries (the bottom are also included):
Switzerland’s economy continues to be characterized by an excellent capacity for innovation and a very sophisticated business culture, ranked 3rd for its business sophistication and 2nd for its innovation capacity. The country is characterized by high spending on R&D.

The United States falls one place and is ranked 2nd this year. The country continues to be endowed with many structural features that make its economy extremely productive and that place it on a strong footing to ride out business cycle shifts and economic shocks. However, a number of escalating weaknesses have taken their toll on the US ranking this year…. More generally, given that the financial crisis originated in large part in the United States, it is hardly surprising that there has been a weakening of the assessment of its financial market sophistication, dropping from 9th last year to 20th overall this year in that pillar.

Singapore moves up two ranks to 3rd place, remaining the highest-ranked country from Asia. The country’s institutions continue to be ranked as the best the world; at a time when confidence in governments in many countries has diminished, they are assessed even more strongly than in past years. Singapore places 1st for the efficiency of its goods and labor markets and 2nd for its financial market sophistication, ensuring the proper allocation of these factors to their best use. Singapore also has world-class infrastructure (ranked 4th), leading the world in the quality of its roads, ports, and air transport facilities. In addition, the country’s competitiveness is propped up by a strong focus on education, providing highly skilled individuals for the workforce. In order to strengthen its competitiveness further, Singapore could encourage even stronger adoption of the latest technologies—especially broadband Internet—as well as the innovative capacity of its companies.
And here is what co-author Xavier Sala-i-Martin (venerable macroeconomist at Columbia) says about the rankings.

Rebecca Wilder

Sunday, September 6, 2009

Serious credit crunch remains; and it will until the labor market turns

In July, the Kansas City Fed reported - they measure the Kansas City Financial Stress Index (KCFSI), which is an composite index of 11 financial variables that reflects stress in the financial system - that the financial system is much improved since late last year, however, financial strain remains above the previous peak on October 1998 (Russian default).

What does this imply about credit flow right now? It's anemic; except for revolving home equity lines of credit, credit extended across all loan types is just a few %-points higher than in January 2008 (nearing two years ago), and falling.

Remarkably, the Federal Reserve Bank (see H.8 Tables here) reports that the U.S. commercial banking system is growing credit over the year, 0.5% in July. However, history foretells that credit extension will fall well after the recession has ended, only recovering after job gains have gotten underway.

It's normal for the banking system not to extend credit when the worthiness of borrowers is questionable. The historical relationship does suggest that the credit crunch will remain in place for some time, with annual credit growth easily falling into negative territory soon. However, history also suggests that a 180-degree turn in credit growth is possible.

Rebecca Wilder

Friday, September 4, 2009

Just so you know, per capita income in Qatar is $103,500... seen on this really cool link (hat tip, reader Jerry):

The data is compiled using the CIA World Factbook. Of course, not every citizen in Qatar is benefiting from that oil money.

Rebecca Wilder

Error correction: the article incorrectly stated that the unit measured was $US when it is $PPP.

Thursday, September 3, 2009

This week’s 'weekly' data shows much of the same: consumer stress

Going forward, it is my very strong belief that the labor market is going to be the key to the re-emergence of consumer spending. This time around, consumer balance sheets are not able to sustain much dissaving (i.e., borrowing from future income). However, consumers can save if income growth comes back. And if the labor market comes back, so too will income growth.

Last week, the BEA reported that salaries and wages grew for the first time since February – with some of that, consumers can increase spending, while at the same time maintain a higher rate of average saving. Of course, the opposite is also true: income growth anew presents a situation where consumers could save even more, i.e., the marginal propensity to save rises – this would wreak havoc, again, on consumer spending.

I tend to “believe” the former (nobody actually knows how consumers will react). But consumption has been pounded in the last year, and I just don’t know how much further it can fall without driving its own demand. Cash for clunkers re-iterated that people want to buy…they might just be smarter about it. It’s all back to income growth.

Consumer-spending-pertinent reports:
Claims and Taxes

Initial Claims are still very, very elevated.

The four week moving average of initial unemployment claims turned positive again this week, growing 4,000. In the four full weeks of August (8/8-8/29), average claims rose 3 out-of 4 times. This is not a good sign, and a clear indication that the labor market might be falling less quickly (its second derivative, that is), but certainly not growing. I still expect a pretty big drop in claims going forward and into the fourth quarter of 2009.

The weak labor market is keeping tax receipt growth in negative territory.

Workers are paying less in taxes, which is a slight reprieve, but look for a positive growth in these daily tax receipts to indicate that labor conditions are markedly improving; that hasn’t happened yet. On September 1, the annual growth rate (of the cumulative sum) in tax receipts jumped above zero, but has been below zero for most days since April. Notably, the number of positive growth points in tax receipts, although still few and far between, and are growing in size.

Rebecca Wilder

Tuesday, September 1, 2009

ISM: a very positive report with strings

The August ISM purchasing manager’s survey today reported that the manufacturing industry is now expanding, with a reading of 52.9%. Yeah!

There are strings, though: the optimism has not yet presented itself in the data quite yet. The index is a diffusion index, which is calculated from a pretty crude survey of manufacturing managers. They are asked how conditions have changed over the month, with answers being categorized according to improved, unchanged, or worsened (or something similar across each of the components).

But the reading above 50, 52.9%, does indicate that the managers surveyed (it does not control for firm size) are now weighted toward the view that the manufacturing sector is generally expanding.

Some responses to the survey:
  • "Production is picking up as demand [for] orders is being accelerated." (Nonmetallic Mineral Products)
  • "Demand from automotive manufacturers increasing thanks to 'Cash for Clunkers.'" (Fabricated Metal Products)
  • "In addition to improved business come the complications of a supply chain drained of inventory." (Paper Products)
  • "The sudden increase in customer demand, plus the low inventories held at services centers, is causing a shortage in the supply of raw steel." (Transportation Equipment)
  • "[It] appears customers' inventories are getting low, and they are cautiously placing orders." (Apparel, Leather & Allied Products)
The components of the survey are also improving, where those circled are very positive, i.e., conditions are improving at a quickening rate. Notably the employment index is still very low, however, consistent with the nonfarm payroll report, the labor market is contracting less quickly.

Still a ways to go before we can break out the champagne – I would like to see industrial production numbers to go along with the survey responses. And remember, expanding is what it is – all one needs is a little growth. From the bottom, that’s relatively easy to get.

Rebecca Wilder