By David Llewellyn-Smith
From the FOMC’s James Bullard via Bloomie:
I also think that inflation expectations are dropping in the U.S. And that is something that a central bank cannot abide. We have to make sure that inflation and inflation expectations remain near our target. And for that reason I think a reasonable response of the Fed in this situation would be to invoke the clause on the taper that said that the taper was data dependent. And we could go on pause on the taper at this juncture and wait until we see how the data shakes out into December. So… continue with QE at a very low level as we have it right now. And then assess our options going forward. …
My forecast is for rising inflation. That’s why I’m concerned about declining inflation expectations, the five-year TIPS in particular has declined below one and a half percent. The five-year forward is down from its previous levels. And the central bank has to guard against any expectations in the market that would suggest that the central bank is not going to hit its inflation target. So you have to be credible on your inflation target. So a simple – what I’m saying is that a simple step that we may be able to take or maybe the committee might consider at its October meeting would be to just take a pause on the taper, let more data accumulate and see how the U.S. is going to evolve over the rest of the year and into next year. …
I think you should quit numbering the QEs. I’ve been an advocate of having an open-ended program. I do think QE is our most powerful tool when the policy rate is at zero. And I think it’s far more powerful than forward guidance for instance. And I think we saw that during the taper tantrum of 2013. And therefore I think I’ve been for having an open-ended program that reacts to economic data. And so far we’ve been able to taper the program down on the face of really dramatically improving labor markets this year, but maybe this is a juncture where we’d want to invoke that clause about it being data dependent.
That’s step one on the road to QE4. Certainly the FOMC jawbone is deployed in an effort to stabilise markets. But it must be remembered that it is the US economy that is currently leading the charge on world growth so we’ll not be seeing any push on policy stimulus unless its data output begins to wane. On the night we saw the opposite with industrial production strong at 1% in September, the Philly Fed easing but still firm at 20.7 points and weekly unemployment at 14 year lows. The other question confronting the Fed of course is what on earth would it would monetise given Treasury output is falling and markets can’t get enough of them anyway. That gives some idea of just persistent and toxic the zero bound can be.
That’s a point made by Deutsche’s George Saravelos via FTAlphaville:
Those looking to the Fed to save the day are looking at the wrong place. First, unlike the September 2013 non-taper, US rates have rallied and American data surprises are close to their highs. Second, this is not about the US but the rest of the world. Bunds and gilts have rallied 9-10% this year compared to a 6% rally in USTs. This is about global, not American fears. It is about how the world transitions away from Fed-driven liquidity (QE winds down this month) to the rest of the world.
He sees help from elsewhere:
1.The ECB needs to start QE
The game is up. Inflation expectations are collapsing, peripheral spreads are widening, equities are selling off, and foreigners are liquidating European assets (charts). The market is pricing policy failure and challenging the ECB. It is Europe’s central bank that now has the biggest role to play in acting as a circuit breaker for markets. A QE move in November should not be taken off the cards, but the bigger the delay and the more timid the action, the more disruptive markets are likely to become.
2. PBoC liquidity
It is not just about Europe. Conditions in China keep tightening and the economy is slowing down. Today’s credit data disappointed, and Bloomberg’s GDP tracker is showing ongoing deceleration (charts). A reserve requirement cut or additional liquidity injections would be a useful complement to ECB action.3. Japan
The Nikkei is tumbling and recent Japanese data have been weak. Kuroda’s QQE runs out next April, completing the “doubling of the monetary base” that was promised two years ago. The more open Kuroda is around extending (upsizing?) the existing program in the upcoming BoJ meeting and outlook report on October 31st, the more this will help.In sum, UST yields below 2% make nice headlines, but this is all about what is happening to the rest of the world, not America. The focus should not be on if Yellen turns more dovish (does she need to?) but on how the liquidity baton is passed from the Fed to the other central banks. It is only once this transition has completed that one can feel more comfortable calling a top in volatility and a bottom in risk assets. It is also precisely because more easing will come from the rest of the world, not the Fed, that the long USD trade remains intact.
Fair enough. But it’s not that simple either is it? The Fed is also, already, explicitly jawboning the US dollar on concerns that stimulus elsewhere will hurt the US economy. European QE isn’t going to do much given the same global deflation scare that has driven down US bonds has crushed EZ yields and the EZ’s monetary transmission mechanism remains broken in the banks, China is not about to pick up the liquidity baton given it’s dedicated to curing its imbalances via the removal of liquidity and Japan is pretty peripheral anyway.
I remain hopeful that the US can drag the world along with it for a little while as oil prices tumble and lower interest rates support its housing recovery. But if it is not able to lead the global economy then it’s still all the way with the USA and QE4!
