"Failure to launch" aka "no rate normalization"

From the Wall Street Journal

 



The chart illustrates how central banks have retraced their rate hikes. The challenge to those those espousing the exclusivity of monetary policy --conventional or otherwise-- is how much monetary tightening can the an economy take at any given point in its business cycle, particularly in a world where rates are close to the nominal zero lower bound.

Focus on front-end yields, because the Fed can’t raise policy rates in a levered economy

The title is the gist of Bill Gross' monthly missive.

Here is the Bond King's takeaway:

If you want to trust one thing and one thing only, trust that once QE is gone and the policy rate becomes the focus, that fed funds will then stay lower than expected for a long, long time. Right now the market (and the Fed forecasts) expects fed funds to be 1% higher by late 2015 and 1% higher still by December 2016. Bet against that.

(underlined emphasis added) 

Read the rest here.

Those opposed to Gross' view will argue that he is talking up his own book. This post does not argue for against that motive: differences of opinion are what makes financial markets tick. But it is worthwhile considering his viewpoint even though no one is infallible.

The current shutdown of the US Government and the upcoming debt ceiling debate is political theater. It warms the cockles of hearts of financial journalists who further conflate the budget of the U.S. government with that of a struggling lower middle class household. Struggling middle class households are not the custodians' of exorbitant privilege.

The United States will default only if it wishes to: as the world's most powerful nation militarily, consumer of last resort, the destination of global capital and preferred destination of global goods, and home to the Mecca of financial capital, Wall Street, there is nothing to benefit the nation were its political class to enforce a default. 

This blogger's view on rates remain unchanged as one could gather from these posts: from 2011, and 2012, and earlier this year.

Time shall tell.

Coming home to Canada, and for those in the circles of punditry forewarning of rising rates to come, they would do well to remember that the country remains a price taker in economic matters that matter. The Bank of Canada cannot go it alone with rate hikes and a floating exchange rate in a world where the five central banks that count in terms of capital markets: U.S. Federal Reserve, European Central Bank, Swiss National Bank, Bank of Japan and Bank of England are undertaking monetary stimulus and, by extension, ensuring financial repression on savers. 

Monetary policy is close to its effective limit here and abroad while the political will to expand fiscal policy is constrained. Absent the financial sector expanding credit channels further to the household sector there is simply nothing on the horizon but (at best) a slow growth recovery in the coming years that will flirt with recession. 

Of course, mortgage rates north and south of the 49th parallel have risen as preemptive exuberance from the bond markets over existential concerns --tapering et al-- created a rush to sell off medium and longer term issues. Moreover,  concern over impending policy hikes in Canada have led households to lock in lest they be caught on the wrong side of rising prime-linked variable mortgages. But the opinion shared here repeatedly since 2011 has been that the policy rate will be going nowhere but in the event it does go higher any hikes are not going to result in rate normalization (defined loosely where the BOC policy rate is at a 200 bp spread above core CPI) that economists have warned about. Looking at the money markets, we see that rate expectations in Canada remain moribund: the OIS curve is pricing no hike over 1 year and little chance over 2 years while the short end of the Canada curve remains popular with little to no liquidity premium over the policy target rate.

Betting against the FOMC

These two slides are from a deck by Vincent Reinhart and Harold Ford Jr. for a Morgan Stanley Conference call.

Referring to the lower chart, if there was a trade then I would take the other side of the "Target Fed Funds Rate" view for the "Longer Run" bucket; it appears (to me)  higher than the U.S. economy could sustain without significant de-leveraging of the private sector and renewed access to cheap credit to smooth consumption for the bottom quartiles of the wage pyramid. Clearly the FOMC believes --explicitly or implicitly-- in the rate normalization hypothesis rather the any manifestation of Irving Fisher's Theory of Great Depressions. Bernanke, a tried and true disciple of the Friedman and Schwartz narrative about the Great Contraction has enacted the "save the banks, save the world" form of monetary engagement but the coming 18 months will give investors, and more importantly working people, a clearer insight to the depths of the malaise. Of all the policy tools available, a form of quantitative easing for the public will not be an option. The global imbalances that have shown the circumspect nature of policy prescriptions from creditor and debtor nations alike will remain; not every nation can trade its way out of the quagmire and not every country can have a current account surplus. In time that longer run view of the target Fed Funds Rate will come down as reality hits the fantasy of Panglossian expectations.