Yellen’ won’t help

I’m going to wonder off the reservation a little today and talk about the Fed, its balance sheet and risk assets.
 
Janet Yellen is Vice Chair to Ben Bernanke at the Fed. She is one of the Fed Governors. I always thought she was pretty switched on but last night she gave a speech  that has me flabbergasted: 

In my remarks today, I will make the case that recent developments in commodity prices can be explained largely by rising global demand and disruptions to global supply rather than by Federal Reserve policy… In my view, the run-up in the prices of crude oil, food, and other commodities we’ve seen over the past year can best be explained by the fundamentals of global supply and demand rather than by the stance of U.S. monetary policy.

She’s joking isn’t she? She must be!

Nope, Yellen believes that it’s all about the growth of the emerging economies and says: 

In my view, the run-up in the prices of crude oil, food, and other commodities we’ve seen over the past year can best be explained by the fundamentals of global supply and demand rather than by the stance of U.S. monetary policy.
 
In particular, a rapid pace of expansion of the emerging market economies (EMEs), which played a major role in driving up commodity prices from 2002 to 2008, appears to be the key factor driving the more recent run-up as well. Although real activity in the EMEs slowed appreciably immediately following the financial crisis, those economies resumed expanding briskly by the middle of 2009 after global financial conditions began improving, with China–which has accounted for roughly half of global growth in oil consumption over the past decade–again leading the way. By contrast, demand for commodities by the United States and other developed economies has grown very slowly; for example, in 2010 overall U.S. consumption of crude oil was lower in than in 1999 even though U.S. real gross domestic output (GDP) has risen more than 20 percent since then. On the supply side, heightened concerns about oil production in the Middle East and North Africa have recently put significant upward pressure on oil prices, while droughts in China and Russia and other weather-related supply disruptions have contributed to the jump in global food prices.
 
In contrast, the arguments linking the run-up in commodity prices to the stance of U.S. monetary policy do not seem to hold up to close scrutiny. In particular, some observers have pointed to dollar depreciation, speculative behavior, and international monetary linkages as key channels through which accommodative U.S. monetary policy might be exacerbating the boom in commodity markets.

Yellen goes on to deal with these in turn in her speech and rather than reprint her words here let me just say she reckons it wasn’t and isn’t the Fed.

Yellen is making this point because she is trying to say that the Fed isn’t responsible for these moves and so the Fed doesn’t need to withdraw stimulus anytime soon because with a weak economy and has no responsibility for the inflation that is rising globally.

But the as I wrote previously “if Central Bankers feel the need to take away the punchbowl earlier than the market expects or the economy can bear I’m fairly sure we will see market ructions erupt” . Yellen may be in the other camp and looking to protect the economy from an early tightening but in not understanding the risks to both sides from QE, it seems to me the chances of a misstep are higher. As I’ve said before I strongly believe the end to QE poses a clear and present danger to markets in general and risk assets in particular.
 
So let’s have a look at what the raw data tells us. The table below is the correlation of the moves between the Fed’s balance sheet and selected assets at monthly rests since the beginning of 2009. What we have is the Dow, S&P 500, Aussie, USD Index, Goldman Sachs Commodity Index and West Texas Intermediate Crude.


 
It would appear to me that somehow, somewhere there is a linkage to the Fed’s monetary policy and moves in these markets. So I find Yellen’s dismissal all the more troubling. This is particularly the case when we know that Chairman Bernanke is on the record as saying that QE was aimed at lifting Equity prices and buttressing confidence while the rest of the economy caught up. Certainly Yellen’s assertion that it’s not just the USD seems to have some credibility on this basis but I’d argue that this was distorted by the original safe haven flow earlier in this period before the USD weakened again in the past 6 months. The chart below shows the USD (DXY) versus the Fed’s balance sheet inverted and I think you’d agree that QE appears to have some role to play in the more recent, and I’d say frothy, move lower in the USD since late last year:

But if I look at a few other markets I see a definite correlation with the Fed’s balance sheet:

Note particularly how the moves tighten up in the past 6 months and particular since the USD has been moving more closely with the Fed’s balance sheet as well
 
Readers know I am leery of correlation without causality but when I look at the moves in asset market since the Fed embarked on its “alternative” monetary operations and expanded its balance sheet via quantitative easing I see Fed induced moves in prices. At the very least the Fed has supported these moves.
 
Why does all this matter? Because if, as I think, the Fed is blowing bubbles and we are in the frothy stage, we have some instability ahead of us later this year when QE ends. Instability that can seriously knock global confidence and growth. Yellen may not be in the camp that says the Fed needs to withdraw the stimulus but her denial of the Fed’s complicity in the moves we are seeing in markets and commodities, and crucially, inflation, worries me because when the stimulus is withdrawn it may be more abrupt than the market is expecting because they simply weren’t considered.

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Comments

  1. The SF Fed did a research piece on this recently, which amounted to data mining in an awfully dishonest way. Given Yellen ‘was’ the President of the SF Fed, it is highly unsurprising to hear her remarks you note above. The frightening thing is how wrong she is. Is is too much to ask to have people in important positions like, say…ooh, the upper echelons of the Federal Reserve…..or the government, that are able to think for themselves? People with only ‘book smarts’ are getting found out like never before. Be nice if they also understoos the monetary system they preside over too, but one thing at a time I guess….

  2. So explain today’s big falls in AUD (in both USD & Euro), ASX, silver, oil etc etc? Has the Fed suddenly shrunk its balance sheet?

    Here’s an article worth reading;

    http://www.bloomberg.com/news/2011-04-12/treasuries-snap-two-day-decline-as-inflation-concerns-ease-stocks-fall.html

    A better explanation is that the Fed is signaling continued bond purchases & the bond speculators are rushing to front-run the Fed, nothing to do with inflation concerns easing.

    Also, the Yen has suddenly made another strong move on the basis of the nuclear disaster being ‘knocked up a notch’, just as it did a few weeks ago. Do I need to spell out the effect on bond speculators of the BoJ buying bonds or even lowering interest rates in the face of disaster?

    Ok, I will, frontrunning the central bank is called a risk free profit.

    • Deus Forex Machina

      Hey JMD…don’t forget we’re looking at monthly correlations in this piece to see the long term impact. Day to day variations won’t be influenced by the Fed’s balance sheets as you imply.
      There is a battle on at the Fed between the Doves and the Hawks over the path of QE. yesterday the Hawks had the floor…we’ll see how it ends but these correlations suggest not well for the bulls…whenever that may be.
      Keep Well…DFM

      • I don’t think you can say the size of the Fed’s balance sheet is causing ‘inflation’, but only as a monthly correlation. The month is made up of the days.

        Also, the article I linked to suggested that the ‘doves’ had the floor, I quote; “Treasuries snapped a two-day slide after Federal Reserve officials William Dudley and Janet Yellen said the economy isn’t strong enough to ease stimulus.”

        This suggests to me that bond speculators i.e. all the various financial types, are expecting to make a quick risk free profit by flipping bonds to the central bank. Central bankers are renowned for their timidity in the face of crisis, especially the BoJ.

        The fact that the Yen is only the obligation of the Japanese government seems lost on most people though.

    • Suggesting more QE? Really? Hmm. They are simply diluting the ramblings of the Fishers of the world, nothing more. There is little prospect of more QE at this point. It has no macroeconomic effects, and is only about pumping up asset prices. Bernanke has even stated the obvious, explicitly, because he casts so much faith in the neoliberal “confidence effects’ view of the world. QE is nothing but a different form of trickle-down economics, and is reprehensible and ineffective as a result.

      It’s difficult to work out if you are responding to my post or going off on a tangent, but I’ll note a couple of inconsistencies within your short post:

      – It doesn’t appear you have read the SF Fed article, but you are making the same mistake….taking a price fluctuation on a single day and extrapolating a conclusion (are you actually Alan Jones?? Or a SF Fed researcher…).
      – markets move ahead of time, they front-run, as you say at the end. If you really understand that, then you’re acknowledging your very first sentence as irrelevant
      – if the Fed really is signalling more QE as you suggest (it isn’t…), then the Aussie dollar doesn’t fall. Period. It goes up. H&H is spot on (4:16pm). QE isn’t inflationary, even if the markets and “traders” think it is. The inflationista wingnuts out there have sold the USD and bid up hard/risk assets because they have this (unsupportable) idea of currency debasement, and can do so with relative impunity (stable funding costs). Even Jim Rogers is long cotton because he thinks teh Fed is printing money! Good traders don’t need to know a lot about macro, or (phantom) money printing, or be right for teh right reasons! They just need to be able to spot opportunity…..and he can.

      Your comment is internally inconsistent. More QE = more speculation for both those reasons above. Therefore, QE3 would = Aussie going through the roof, not falling.

      What QE is, in fact, is a one-way bet for speculators. “Extended period” language at the FOMC is completely irrelevant when you’re undertaking QE – rates are low for an “extended period” by definition….until QE stops, that is. At that point, the one-way bet evaporates. The only exit strategy i foresee is not so much an issue for the Fed, but for the markets. Think longs in risk assets wait until June 30 to take profits/unwind etc. I don’t see why they would.

      Finally, if the markets were front-running the Fed, bonds would be rallying like stink (like all cases of pre-QE), not [email protected] around as they currently are. They’ll do that when QE ends, I have little doubt. QE has been a monumental real macro failure so far, and will be so again should the Fed decide to repeat (once again, they won’t, they can’t be that stupid, surely).

      You note inflation easing….which is the only thing I can agree with. It was never looking like breaking out anyway, not with a 5% output gap.

      You need to reconsider your comments.

  3. It was the Fed and govts. distortions (see interference) in markets that reduced the USA’s ability to create productive jobs in productive industries over time. Their solution to this……create ever more distortions in the economy via QE.

    Printing money causes inflation. To say otherwise is ridiculous and contrary to every countries experience who has ever expanded the monetary suply on a grand scale. Prices on some goods rise faster and earlier than others (commodities). The point is that you have artificial increases in price and you can’t actually tell how much is from an increase in the underlying demand (if at all).

  4. RE: Yellen’s comments on EMEs (read: China) driving demand for commodities:

    I wonder if Ms Yellen noticed that almost all the post-GFC growth in China is investment supported by ultra-loose credit conditions. She might argue that Fed policy is not affecting commodity prices, but surely she can’t argue that Chinese monetary and fiscal policy isn’t playing a role?

  5. Adonis

    I was just going to link to this. Still will:
    http://www.frbsf.org/publications/economics/letter/2011/el2011-10.html

    plus a lengthy piece from Pater Tenebrarum which also references the SF Fed research (if that is what is can be called).

    http://www.acting-man.com/?p=7051

    Excerpt
    “Two economists at the Federal Reserve Bank of San Francisco, Reuven Glick and Sylvain Leduc have just reached the conclusion that Fed money printing doesn’t cause price inflation. In fact they go one better, they claim that Federal Reserve asset purchases (which create money out of thin air) are deflationary. I am not making this up. Here’s the introduction to their argument:

    Prices of commodities including metals, energy, and food have been rising at double-digit rates in recent months. Some critics argue that Federal Reserve purchases of long-term assets are fueling this rise by maintaining an excessively expansionary monetary stance. However, daily data indicate that Federal Reserve announcements of large-scale asset purchases tended to lower commodity prices even as long-term interest rates and the value of the dollar declined.

    What makes them so sure about this price deflation? They start off by telling us this:

    …commodity prices have surged since Chairman Bernanke’s Jackson Hole speech. The Goldman Sachs Commodity Index, a heavily traded broad index of spot commodity prices, rose 35% between the Jackson Hole speech and the end of February. The increase was widespread, spanning a range of commodity categories. Industrial metals rose nearly 30%, energy prices climbed 35%, and food prices rose close to 50% during the six-month period.

    So how with these facts do they reach their conclusion. They argue this way:

    The LSAP [Large Scale Asset Purchases] announcements about monetary policy may have signaled that the Fed perceived economic conditions to be weaker than previously thought. Alternatively, they may have increased market worries about risk and made Treasury securities more desirable as safe-haven investments. Thus, an announcement that makes investors feel that conditions are worse than originally perceived or that heightens risk concerns may lead investors to increase their demand for Treasuries, lowering their yields. These concerns also could reduce investor demand for other assets, such as commodities, resulting in lower prices.

    They then go on to report on an absurd empirical study that they completed. There are methodological problems with empirical studies in the first place in the social sciences, but this study is over the top in its poor structure.”

    • Unbelievable isn’t it? The Fed can do some great, great stuff (and my favourite to this day is a rejection of the money multiplier), but then this? If they want to model X’s effect on Y, where Y is a market variable, then I suggest they run it past some of those friendly market folk for

      a) some levity during a busy day; and
      b) a steer in the right direction

      I’ve not heard of that acting-man site, but look fwd to having a gander. Thanks.

  6. In my view, DSM is spot on. I don’t think $600 billion is enough to cause global commodity inflation of the degree we have seen. Unless you see markets as operating not on real monetary processes but signals of monetary processes. By that I mean that traders bet on commmodites going up because the Fed is doing what it’s doing not because there’ll actually be inflation coming out of it. Hence we get inflation anyway. It’s a bit like inflation expectations, only for traders…

    • The IMF is saying emerging economies will grow at 6.5 per cent this year. That underpins a lot of commodity demand.

  7. Forget yellen and her silly twat…we wanna know if the great one will keep printing or not? more inflation and higher gas and food or the economy and stocks will take a death spiral. I think he might take the foot off the pedal then shit his pants and keep printing, ive got the pop corn out, good luck amigos either way we are F – – K – D.

  8. Your graphs are not convincing, since the units on the right side are not proportional to those on the left.