Tornado Alley (PROG)

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Kocherlakota and the Cultists

January 28, 2014, 1:36 pm

Narayana Kocherlakota, president of the Minneapolis Fed, is the prodigal son of monetary stimulus. He was the Fed’s leading hawk a few years ago, reflecting in part the ultra-freshwater macro doctrines of the Minnesota econ department and his bank’s closely associated research department. But he did something amazing: he looked at evidence, listened to his critics, and changed his views .. http://www.nytimes.com/2014/01/28/business/a-federal-reserve-policy-maker-urges-it-to-do-more.html?smid=tw-share&_r=0 — becoming the Fed’s leading dove.

This is totally praiseworthy, especially because it almost never happens.

Binyamin Applebaum’s article on NK also contains dramatic evidence of the intellectual climate from which he had to emancipate himself, in the form of an email from Ed Prescott, founder and relentless promoter of real business cycle theory. Prescott:

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It is an established scientific fact that monetary policy has had virtually no effect on output and employment in the U.S. since the formation of the Fed.
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In reality, few if any topics in economics have been studied as thoroughly as the real effects of monetary policy. And the overwhelming consensus, from multiple lines of inquiry — Sims-type econometrics, Romer-Romer style event studies, Mussa-style comparisons of exchange regimes (which are also monetary policy regimes) — is that monetary policy has powerful real effects. This consensus could be wrong — such things have happened — and Prescott could make the case that the consensus is wrong. But that’s not what he’s saying. He’s declaring it “an established scientific fact” that what everyone outside his sect believes is totally false.

That’s not science, whatever Prescott may think; it’s being part of an irrational cult. And kudos to Kocherlakota for learning to stop drinking the Kool-Aid.

http://krugman.blogs.nytimes.com/2014/01/28/kocherlakota-and-the-cultists/

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July 7, 2013, 8:27 am
That Terrible Taper

One of the odd things about the people arguing that we must raise interest rates to head off bubbles — Raghuram Rajan, Martin Feldstein, the BIS, and so on — is the near-universal assertion among this group that just a little rate increase can’t do any real harm. (Just a thin little mint). After all, rates are so low!

As I’ve argued, this is a novel economic principle; where else do we argue that demand curves (in this case the demand for investment) are vertical at low prices? But it has occurred to me that it might be helpful to look at what the partial victory of these people — their implicit success in bullying the Fed into talking about tapering despite a still very weak, low-inflation economy — has wrought. Bear in mind that the interest rates that matter most for the economy are not the rates at which the government can borrow, but the rates facing private investors — and above all, mortgage rates, for housing is the most important transmission mechanism for monetary policy. And here’s what we see for mortgage rates since the talk of tapering began:



Do you really think that this will have no effect? Really, really?

By the way, I see that some readers imagine that the effects of the taper talk somehow refute my earlier assertions that the rate at which the Fed is buying long-term bonds has little effect on interest rates. But you’re misunderstanding both what I said and what is happening now. My point was always that the direct effects of bond purchases were small, so that anticipated changes in the pace of purchases — like the end of QE2 in 2011 — had minimal effects.

What’s happening now, however, is that the taper talk has led to a sharp revision of market expectations about the path of short-term interest rates, which the Fed does control. From Gavyn Davies .. http://blogs.ft.com/gavyndavies/2013/06/28/how-the-fed-lost-control-of-short-term-interest-rates/ :

The Fed didn’t mean this to happen; it tried to communicate that it wasn’t changing the path of short-term rates; but this was naive on its part. The Fed can’t really commit to future policy; all it can do is signal its character .. http://krugman.blogs.nytimes.com/2013/06/30/historic-mistake-watch/ , and what it ended up doing here was convey the sense that it’s much more inclined to tighten too soon than previously thought.

So it’s a bad story, all around.

http://krugman.blogs.nytimes.com/2013/07/07/that-terrible-taper/

.. yep, still working to understand more nitty-grunty about this stuff .. edit add ..

Bernanke won't blow up bond market

By Stephen Gandel, senior editor June 19, 2013: 1:28 PM ET

The Federal Reserve may not be the big bad wolf of the bond market, despite what some say.

FORTUNE -- The last of the economy's Band-Aids are coming off. The question is how much it will hurt.

So far the answer from the bond market has been quite a lot. The yield on 10-year Treasuries spiked to 2.3% Wednesday after the Federal Reserve chairman Ben Bernanke indicated that .. http://money.cnn.com/2013/06/19/news/economy/federal-reserve-stimulus/index.html , yes, the bond stimulus will come to an end. Not immediately, or all at once. But Bernanke said if the economy remains on its current path he expects the Fed to curtail bond purchases later this year, and stop completely by mid-2014 if the unemployment rate hits 7%.

With Wednesday's move, bond yields have risen 0.8 percentage points in about a month. That might not sound like a lot, but the move translated into a 8% drop in prices for the 10-year. Bond investors aren't used to those kind of losses.

MORE: Why Bernanke can't win - http://finance.fortune.cnn.com/2013/06/18/why-bernanke-cant-win/

Some, though, are hunkering down for much worse .. http://money.cnn.com/2013/05/23/investing/fed-bond/index.html . A stream of boldface names, including Warren Buffett .. http://finance.fortune.cnn.com/2013/05/04/buffett-worries-about-feds-huge-experiment/ , Jamie Dimon .. http://finance.fortune.cnn.com/2013/06/06/jamie-dimon-volatility/ , and Goldman Sachs' (GS .. http://money.cnn.com/quote/quote.html?symb=GS ) CEO Lloyd Blankfein and COO Gary Cohn .. http://finance.fortune.cnn.com/2013/01/30/goldman-sachs-bond-market/ , have told us to watch out for rising interest rates. Most of them have focused on what will happen when the Fed stops buying. With that much buildup, it's no surprise that investors have rushed for the gates now that Bernanke has signaled the final countdown. The problem is there's no real evidence the Fed's moves will blow up the bond market, at least not if investors keep their heads.

You can blame the Fed itself for some of the frenzy. Last year, the Fed said it wouldn't raise short-term interest rates, which are near zero, until the unemployment rate hits 6.5%. There is no target for when the Fed will end its quantitative easing program. That's created some confusion in the bond market and caused interest rates to move up faster .. http://finance.fortune.cnn.com/2013/06/14/rising-interest-rates/ .. than if the Fed had laid out when they would stop buying bonds and how much at a time. The Fed came closer Wednesday for setting down some guidance as to when QE would end, but Bernanke qualified his 7% target, saying the Fed would adjust its view on the program based on the economic outlook. "Not having consistent guidance has been a mistake," says Vincent Reinhart, a Morgan Stanley strategist and former top Fed economist.

MORE: Bond investors have already been pulling out before the Fed meeting
http://finance.fortune.cnn.com/2013/06/19/bonds-ben-bernanke-fed/money.cnn.com/2013/06/19/investing/bonds-fed-bernanke/index.html

But what is also true is that stream of debt doom worriers (which I have to say at times has included me .. http://finance.fortune.cnn.com/2013/02/11/banks-bond-bubble/ ) has made the Fed and its buying seem more important to the bond market than it may actually be. The Fed owns just under $2 trillion in Treasury bonds. That's less than 20% of the nearly $16 trillion in U.S. debt.

Still, much of that is not traded regularly. Banks, sovereign wealth funds, and other large investors own a similarly big amount of U.S. bonds as Bernanke & Co. And they aren't likely to sell even if prices drop. The Fed, too, says it has no plans to sell off its own holdings.

MORE: Don't believe Alan Greenspan's bullish case for stocks
http://finance.fortune.cnn.com/2013/06/19/dont-believe-alan-greenspans-bullish-case-for-stocks/

Currently, the Fed is adding $85 billion a month to its bond portfolio. Of that, slightly more than half, $45 billion, in going into Treasuries. The rest is going into mortgage bonds.

How does that compare to what's being sold? In May, Uncle Sam issued $184 billion in debt that won't come due for a year or more. In April, the Treasury sold $282 billion in similar debt. So the Fed is not exactly cornering the market with its bond purchases. And most Treasury bond auctions continue to be oversubscribed.

"There are other natural buyers of U.S. government debt that will step in that have been crowded out by the Fed," says Shyam Rajan, a U.S. rate strategist at Bank of America Merrill Lynch.

Yes, retail investors have been pulling their money out of bond funds .. http://money.cnn.com/2013/07/01/retirement/bond-funds.moneymag/index.html . But those mutual funds are a much smaller portion of the market than they were back in the mid-1990s. What's more, the amount of new debt is likely to shrink in the coming months. The CBO and others recently predicted that an improving economy and higher tax revenue could cause the U.S. deficit to fall to around $650 billion this fiscal year, down from $1.1 trillion. If that's true, the Fed could theoretically cut its bond purchases back and still have the same impact that it is currently having by buying $45 billion a month.

"With the government dramatically reducing amount of issuance, the reduced buying from the Fed could still have the power to keep rates low," says Scott Colyer of Advisors Asset Management.

When you look at the daily trading volume for the bond market, the Fed's importance is even smaller. An estimated $350 billion of Treasury bonds are bought and sold each day. Spread the Fed's $45 billion in purchases over the course of the month, and that works out to just 0.4% of overall Treasury bond market activity on a daily basis.

And that's if the Fed were to stop all of its purchases at once, which it isn't likely to do. More likely, the Fed would cut back bond purchases gradually, $5 to $10 billion at a time. That pullback could be spread between the Treasury and mortgage markets.

"My anticipation is the that the end of QE will be like going to the dentist," says long-time fed watcher Bob Eisenbeis of Cumberland Advisors. "The anticipation is worse than that actual visit."

http://finance.fortune.cnn.com/2013/06/19/bonds-ben-bernanke-fed/

.. i think those kinda synchronize .. LOL ..