The Fed Waits, Impatiently

 
Janet-Yellen
Janet Yellen.

The Federal Reserve meeting ending today has been discussed, chewed on, and predicted by just about everyone with any knowledge of the identity of Ben Bernanke or Janet Yellen. Let’s dissect the run-up, and see what they did.

The Washington Post ran a Wonkblog article titled “The Federal Reserve confronts a possibility it never expected: No exit.” When Chair Yellen began her post, the author writes, they developed a blueprint for lifting up from the zero boundary of short-term interest rates and reducing the Fed’s now-massive balance sheet. The two-year-old strategy has not really been enacted, with only one rate rise since its adoption and no shrinking of the balance sheet. So, says Wonkblog, the Fed must be stuck.

There are of course those who wish the Fed to stay stuck. Former Minneapolis Fed president Naryana Kocherlakota is emblematic of the view that the Fed is stuck because, in short, they are screwed either way they turn.

Yields on Treasury bonds suggest that traders expect inflation to average less than 2 percent five to 10 years from now. As the experience of the Bank of Japan indicates, restoring such confidence is not easy.

The Fed is also falling short of its goal of “maximum” employment. Although the unemployment rate has returned to its 2007 level of 5 percent, the fraction of Americans in their prime working years who have a job remains well below its pre-recession level.

All this argues for the Federal Open Market Committee, the central bank’s policy-making arm, to provide added stimulus by cutting interest rates a quarter percentage point at its Sept. 21 meeting.

…Unfortunately, I’m confident that the Fed won’t cut rates. Doing so now might require officials to raise rates more rapidly in the future — an outcome that they are, for reasons that are unclear to me, determined to avoid.

So the central bank will either raise rates by a quarter percentage point or do nothing. The latter appears more likely, given that two Fed governors have spoken out in favor of caution. The last time the Fed took an action from which two governors dissented was in 1993. In either case, it will be the wrong move.

Who would those governors be? Clearly Lael Brainerd — an early favorite for Treasury Secretary in a potential Clinton administration — is not down with a rate increase. And Dan Tarullo — another Obama appointee and former Bill Clinton administration official — made noises earlier in the month against a rate hike. Even though at least seven Fed presidents and governors have supported a rate hike, the chances of it happening appeared to be small this morning, particularly after Japan announced this morning they would target a zero rate on their ten-year government bond.

And changing interest rates isn’t just something you don’t do with dissent — it’s seldom done when close to an election. George H.W. Bush long believed that Alan Greenspan (!) cost him the election in 1992 by not cutting interest rates that year. It is why I have long thought the Fed would use September to lay the groundwork for a rate increase in December, but not before.

So what happened? A remarkable ending:

…the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives.

…Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action were: Esther L. George, Loretta J. Mester, and Eric Rosengren, each of whom preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.

Three dissents! Mester and Rosengren are new, while George has been a dissenter for quite a while. This is a remarkable outcome that usually happens when the FOMC is deeply divided. It happened in 1972, though, when Fed presidents (those heading the district banks, not the governors in DC) argued for tighter policy. It happened again in July 1979, just before Paul Volcker started the process of massively raising interest rates to choke off stagflation (and the double-dip recession of 1980 and 1982.) There may be other times this has happened, but suffice to say it’s rather rare, particularly since 1980.

Two other pieces of information that bear pointing out:

  1. If you look at page three of the economic projections of the FOMC you see the “dot plot” of interest rates for end-2016, with only three members of 17 expecting the rates to stay the same as now. This will cause nearly everyone to expect a rate increase in December, though the data-dependency language of the FOMC statement will give them the wiggle room to balk yet again. Still, as BankRate.com’s chief financial analyst put it, the Fed is getting antsy to raise rates.
  2. Ms Yellen is a bit prickly over Donald Trump’s assertion of the Fed being politically motivated. “The Federal Reserve is not politically compromised,” she answered in response to a question. “I have no concern that the Fed is politically motivated and I assure you you will not find any signs of political motivation when the transcripts are released in five years.” Of course, five years is a long time, probably past the point where Ms Yellen will be chair. And she would not attach political uncertainty to her observation that business investment is low.

We will ignore the meeting on November 1-2, then, and be back to discuss the rate hike that now appears likely on December 14.

There are 20 comments.

  1. Basil Fawlty Member

    The Fed waits, impotently.

    • #1
    • September 21, 2016, at 3:31 PM PDT
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  2. Z in MT Inactive

    As predicted. It’s simple. Janet Yellen is a Democrat and raising interest rates would potentially hurt Clinton if the market tanked.

    • #2
    • September 21, 2016, at 4:26 PM PDT
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  3. Steve C. Member

    Oyez, oyez. It is decreed by the best and the brightest, that the price of money shall remain cheap. Implying the demand for money is low. Ergo it is necessary for the Federal Reserve to pay banks interest on reserves because, well, because, umm, well, there’s no demand for money.

    According to Janet “I am not familiar with this first rule of holes thing” Yellen, the solution to all our economic problems is to be just like the Japanese. Only with the death penalty.

    • #3
    • September 21, 2016, at 4:53 PM PDT
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  4. Z in MT Inactive

    Steve C.:Oyez, oyez. It is decreed by the best and the brightest, that the price of money shall remain cheap. Implying the demand for money is low. Ergo it is necessary for the Federal Reserve to pay banks interest on reserves because, well, because, umm, well, there’s no demand for money.

    According to Janet “I am not familiar with this first rule of holes thing” Yellen, the solution to all our economic problems is to be just like the Japanese. Only with the death penalty.

    I have been saying this for a while now. We are Japan just a decade or so behind. Japan is now going on 30 years of near zero interest rates with low growth and low inflation (slightly deflationary). Why the Fed thinks copying Japan will lead to a different outcome I don’t know.

    • #4
    • September 21, 2016, at 5:14 PM PDT
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  5. Herbert defender of the Realm,… Inactive

    What do you think of The Donald’s idea that now is the time to be locking in more long-term debt?

    • #5
    • September 21, 2016, at 6:28 PM PDT
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  6. King Banaian Contributor
    King Banaian Post author

    Herbert:What do you think of The Donald’s idea that now is the time to be locking in more long-term debt?

    Much of corporate and household debt is tied to rates on long-term government bonds. Selling more long-term debt is likely to hurt housing and investment, while not doing much to increase the return to saving (which I didn’t have time to discuss in my post, so let me outsource that to John Mauldin.)

    • #6
    • September 21, 2016, at 6:47 PM PDT
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  7. Steve C. Member

    Herbert:What do you think of The Donald’s idea that now is the time to be locking in more long-term debt?

    And do what? Government is not a business. The government can’t borrow $25 billion and put it in a sock drawer. The federal government borrows money to pay it out. Whether that’s to pay interest to bond holders, grandma’s Social Security check or cannons from the Krupp family.

    • #7
    • September 21, 2016, at 7:20 PM PDT
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  8. The Reticulator Member

    “The Federal Reserve is not politically compromised,” she answered in response to a question. “I have no concern that the Fed is politically motivated and I assure you you will not find any signs of political motivation when the transcripts are released in five years.”

    Why would one expect to find evidence of political motivation in the transcripts? The Fed governors may not be smart enough to get themselves out of the hole they’ve dug for the economy, but they’re not stupid enough to put their political machinations in transcripts, are they?

    • #8
    • September 21, 2016, at 8:29 PM PDT
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  9. I Walton Member

    Kudlow agrees that the fed isn’t politically motivated, that there is no direct political link. What is the difference between politically motivated in the sense of making explicit deals, and sharing a rigid ideology that serves each others interests? The Fed has been monetizing debt which the Obama Administration uses in ways that sustain stagnation which reduces demand for credit, keeping the money base from turning into money. How to get off this tiger if at some point the powers so choose? Hillary won’t try, Trump may have to face the decision if he actually cuts taxes and deregulates giving rise to economic expansion and hence an increase demand for credit. Hold your hats.

    • #9
    • September 21, 2016, at 8:32 PM PDT
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  10. The Reticulator Member

    I Walton:Kudlow agrees that the fed isn’t politically motivated, that there is no direct political link. What is the difference between politically motivated in the sense of making explicit deals, and sharing a rigid ideology that serves each others interests? The Fed has been monetizing debt which the Obama Administration uses in ways that sustain stagnation which reduces demand for credit, keeping the money base from turning into money. How to get off this tiger if at some point the powers so choose? Hillary won’t try, Trump may have to face the decision if he actually cuts taxes and deregulates giving rise to economic expansion and hence an increase demand for credit. Hold your hats.

    President Obama has announced, in public, that he approves of Yellen/Fed policies. In April he met with Yellen. He said he didn’t discuss interest rates with her, as if that somehow makes such a meeting appropriate.

    When things like this are allowed to happen, the Fed is hopelessly compromised and politicized.

    • #10
    • September 21, 2016, at 9:14 PM PDT
    • Like
  11. Z in MT Inactive

    Steve C.:

    Herbert:What do you think of The Donald’s idea that now is the time to be locking in more long-term debt?

    And do what? Government is not a business. The government can’t borrow $25 billion and put it in a sock drawer. The federal government borrows money to pay it out. Whether that’s to pay interest to bond holders, grandma’s Social Security check or cannons from the Krupp family.

    The Treasury doesn’t have to increase the size of the debt to shift the maturity of the current debt to longer terms. The Treasury is in fact trying to shift new issues to longer debt maturity. It’s probably the prudent thing to do, but it does increase interest payments in the short term because the yield curve while surprisingly flat is still positive.

    • #11
    • September 21, 2016, at 9:18 PM PDT
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  12. Douglas Inactive

    Z in MT:As predicted. It’s simple. Janet Yellen is a Democrat and raising interest rates would potentially hurt Clinton if the market tanked.

    This is pretty much it. Use Fed policy to feed a stock market under a Democrat, and if a Republican wins, suddenly raise rates. Watch.

    • #12
    • September 21, 2016, at 9:21 PM PDT
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  13. Z in MT Inactive

    I Walton:Kudlow agrees that the fed isn’t politically motivated, that there is no direct political link. What is the difference between politically motivated in the sense of making explicit deals, and sharing a rigid ideology that serves each others interests? The Fed has been monetizing debt which the Obama Administration uses in ways that sustain stagnation which reduces demand for credit, keeping the money base from turning into money. How to get off this tiger if at some point the powers so choose? Hillary won’t try, Trump may have to face the decision if he actually cuts taxes and deregulates giving rise to economic expansion and hence an increase demand for credit. Hold your hats.

    The Obama deficits are only a marginal reason for the stagnation we have had for the past 7 years. Stagnation is not the cause of weak credit demand, low interest rates are the reason for stagnation. The issue is that you don’t get growth the financial sector taking risk, but the zero interest rate environment forced by the Fed allows bankers to make risk-free profits by borrowing money from the Fed and giving it to the government which magically makes it disappear into the black-hole known as entitlements. Yes, that money appears in the economy as checks to retirees and payments to hospitals, but that is money that was already a liability on the government books. So it is a weird form of deleveraging.

    con’t

    • #13
    • September 21, 2016, at 9:27 PM PDT
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  14. Z in MT Inactive

    Another issue is that because high quality corporate bond rates are also low, corporations can increase the price of their stock with share repurchases instead of investing in productivity improvements and future business.

    If the Fed purposely inverted the yield curve, all of this would be reversed. The banks and businesses would have to make long term investments in productivity and future business, which would lead to innovations and real growth.

    They will never listen to me however.

    • #14
    • September 21, 2016, at 9:33 PM PDT
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  15. Z in MT Inactive

    Douglas:

    Z in MT:As predicted. It’s simple. Janet Yellen is a Democrat and raising interest rates would potentially hurt Clinton if the market tanked.

    This is pretty much it. Use Fed policy to feed a stock market under a Democrat, and if a Republican wins, suddenly raise rates. Watch.

    I wouldn’t take that bet. If Trump wins we can expect possibly a 1/2% increase in the Fed funds rate. As I discuss in my other comments, I say bring it on as it is the only way we are going to get out of this low-interest rate environment induced doldrums.

    • #15
    • September 21, 2016, at 9:39 PM PDT
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  16. Herbert defender of the Realm,… Inactive

    Z in MT:

    Steve C.:

    Herbert:What do you think of The Donald’s idea that now is the time to be locking in more long-term debt?

    And do what? Government is not a business. The government can’t borrow $25 billion and put it in a sock drawer. The federal government borrows money to pay it out. Whether that’s to pay interest to bond holders, grandma’s Social Security check or cannons from the Krupp family.

    The Treasury doesn’t have to increase the size of the debt to shift the maturity of the current debt to longer terms. The Treasury is in fact trying to shift new issues to longer debt maturity. It’s probably the prudent thing to do, but it does increase interest payments in the short term because the yield curve while surprisingly flat is still positive.

    I agree with that, but trump has also said that going into more debt when interest rates are so low is a prudent thing to be doing…

    • #16
    • September 21, 2016, at 9:49 PM PDT
    • Like
  17. I Walton Member

    Z in MT:

    I Walton:

    The Obama deficits are only a marginal reason for the stagnation we have had for the past 7 years. Stagnation is not the cause of weak credit demand, low interest rates are the reason for stagnation. The issue is that you don’t get growth the financial sector taking risk, but the zero interest rate environment forced by the Fed allows bankers to make risk-free profits by borrowing money from the Fed and giving it to the government which magically makes it disappear into the black-hole known as entitlements. Yes, that money appears in the economy as checks to retirees and payments to hospitals, but that is money that was already a liability on the government books. So it is a weird form of deleveraging.

    con’t

    The stagnation comes from regulations, uncertainty caused by both the regulations, taxes, rhetoric of an anti small business environment, and a hovering bureaucracy. Low interest rates come from lack of demand for credit which comes from low entrepreneurial activity, weak small business. Also these instruments are being stored in the Fed which isn’t interest rate sensitive. You’re right by monetizing debt they get to enrich favored financial institutions while letting Obama spend without having to raise taxes. The money base doesn’t become money supply. This isn’t from velocity, (at least yet) it’s the money multiplier. Stagnation suits their purpose. If Trump deregulates and cuts taxes we’ll see if I’m right.

    • #17
    • September 22, 2016, at 9:00 AM PDT
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  18. Cato Rand Reagan

    How can this be? I distinctly remember Ben Bernanke promising that the Fed would be able to unwind. (Starting at about the 4:40 mark)

    • #18
    • September 22, 2016, at 12:35 PM PDT
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  19. Cato Rand Reagan

    King Banaian:

    Herbert:What do you think of The Donald’s idea that now is the time to be locking in more long-term debt?

    Much of corporate and household debt is tied to rates on long-term government bonds. Selling more long-term debt is likely to hurt housing and investment, while not doing much to increase the return to saving (which I didn’t have time to discuss in my post, so let me outsource that to John Mauldin.)

    On top of that, even though rates are historically low, the yield curve is hardly flat now, and could be expected to steepen if the treasury made a big move to shift to longer term debt. That’d have a pretty dramatic budgetary impact. The sad fact is that we’re so mired in debt that it’s probably difficult to take advantage of locking in low rates without generating another deficit explosion.

    • #19
    • September 22, 2016, at 12:44 PM PDT
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  20. Herbert defender of the Realm,… Inactive


    https://www.google.com/amp/www.cnbc.com/amp/2016/08/11/king-of-debt-donald-trump-now-is-the-time-to-borrow.html?client=safari

    • #20
    • September 22, 2016, at 1:59 PM PDT
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