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Off the Charts: Dire Warnings About Fed Strategy Did Not Come to Pass

June 28, 2013 by Leave a Comment

While the first such program had started at the height of the credit crisis in 2008, the new program came when the economy was growing, and it was subjected to immediate and withering criticism, particularly from conservatives fearful it would set off inflation and unimpressed by the Fed’s belief that action was needed to spur job growth.

A group of 43 economists, including former aides to Republican presidents and presidential candidates, published an open letter to the Fed’s chairman, Ben Bernanke, saying the program should be “reconsidered and discontinued.” The planned bond purchases “risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment,” the economists wrote.

The Fed did not back down, and Republican efforts to pass legislation removing the Fed’s mandate to seek full employment were not successful. The next year, the Fed moved on to what became known as QE3, also known as Operation Twist, an effort to bring down long-term interest rates by purchasing longer-term Treasuries. That move was criticized by Republican leaders even before it was announced. “We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy,” the Congressional leadership said in a letter sent to Mr. Bernanke while the Fed was meeting.

Now, the Fed is again under attack, as officials discuss the possibility of slowing the pace of bond purchases later this year, and of possibly ending the program as early as 2014. That talk has caused interest rates to rise and led to warnings of large losses for bond investors, amid complaints that it is still too early to proclaim that the recovery has gathered strength.

Losses for bond holders are sure to happen at some point, assuming interest rates return to more normal levels, and this week’s downward revision of first-quarter economic growth may provide a warning that the Fed’s growth expectations, which are more robust than those of many economists, may be too rosy. Navigating an end to quantitative easing, whenever that becomes necessary, may yet prove to be tricky.

But as the accompanying charts indicate, the Fed’s critics of 2010 and 2011 have not proved to be prescient. Far from bringing disaster, QE2 appears to have helped the economy.

It is remarkable how close many markets are now to where they were when the Fed announced the new program on Nov. 3, 2010. The recent rise in 10-year Treasury bond rates has left the yield just a little lower than it was as the program began. The price of gold spiked to record highs in 2011, but is now down about 10 percent from its pre-QE2 level.

In 2010, there were complaints from developing countries that the Fed was trying to drive down the value of the dollar, something Fed officials denied even while conceding the program could temporarily have that effect. Now the dollar index — based on the value of the American currency against six major foreign currencies — has recovered all the lost ground.

Inflation has been quiet, and perhaps more important from a central bank perspective, inflationary expectations remain subdued. Such expectations can be inferred by comparing yields of inflation-protected Treasury securities to ordinary Treasuries of the same maturity. The chart shows what the markets expect inflation will be in five years.

For a time last year, the markets were expecting deflation — a far cry from the runaway inflation that was feared by Fed critics in 2010. Now, the expectation is for inflation of a little over 1 percent — or less than the expectation when the QE2 program was begun.

The decline in unemployment since the Fed began QE2 has been steady but hardly inspiring, and there are still fewer people working than there were before the credit crisis began in 2008. But consumer confidence has been rising recently and the stock market, despite some recent Fed-induced jitters, remains more than 30 percent above its level when the program began.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/06/29/business/economy/dire-warnings-about-fed-strategy-did-not-come-to-pass.html?partner=rss&emc=rss

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Off the Charts: Predictions on Fed Strategy That Did Not Come to Pass

June 28, 2013 by Leave a Comment

While the first such program started at the height of the credit crisis in 2008, the new program came when the economy was growing, and it was subjected to immediate and withering criticism, particularly from conservatives fearful it would set off inflation and unimpressed by the Fed’s belief that action was needed to spur job growth.

A group of 43 economists, including former aides to Republican presidents and presidential candidates, published an open letter to the Fed’s chairman, Ben Bernanke, saying the program should be “reconsidered and discontinued.” The planned bond purchases “risk currency debasement and inflation, and we do not think they will achieve the Fed’s objective of promoting employment,” the economists wrote.

The Fed did not back down, and Republican efforts to pass legislation removing the Fed’s mandate to seek full employment were not successful. The next year, the Fed moved on to what became known as Q.E.3, also known as Operation Twist, an effort to bring down long-term interest rates by purchasing longer-term Treasuries. That move was criticized by Republican leaders even before it was announced. “We have serious concerns that further intervention by the Federal Reserve could exacerbate current problems or further harm the U.S. economy,” the Congressional leadership said in a letter sent to Mr. Bernanke while the Fed was meeting.

Now, the Fed is again under attack, as officials discuss the possibility of slowing the pace of bond purchases later this year, and of possibly ending the program as early as 2014. That talk has caused interest rates to rise and led to warnings of large losses for bond investors, amid complaints that it is still too early to proclaim that the recovery has gathered strength.

Losses for bond holders are sure to happen at some point, assuming interest rates return to more normal levels, and this week’s downward revision of first-quarter economic growth may provide a warning that the Fed’s growth expectations, which are more robust than those of many economists, may be too rosy. Navigating an end to quantitative easing, whenever that becomes necessary, may yet prove to be tricky.

But as the accompanying charts indicate, the Fed’s critics of 2010 and 2011 have not proved to be prescient. Far from bringing disaster, Q.E.2 appears to have helped the economy.

It is remarkable how close many markets are now to where they were when the Fed announced the program on Nov. 3, 2010. The recent rise in 10-year Treasury bond rates has left the yield just a little lower than when the program began. The price of gold spiked to record highs in 2011 but is now down about 8 percent from its pre-Q.E.2 level.

In 2010, there were complaints from developing countries that the Fed was trying to drive down the value of the dollar, something Fed officials denied while conceding that the program could temporarily have that effect. Now the dollar index — based on the value of the American currency against six foreign currencies — has recovered all the lost ground.

Inflation has been quiet, and perhaps more important from a central bank perspective, inflationary expectations remain subdued. Such expectations can be inferred by comparing yields of inflation-protected Treasury securities to ordinary Treasuries of the same maturity. The chart shows what the markets expect inflation will be in five years.

For a time last year, the markets were expecting deflation — a far cry from the runaway inflation feared by Fed critics in 2010. Now, the expectation is for inflation of a little over 1 percent — or less than the expectation when the Q.E.2 program was begun.

The decline in unemployment since the Fed began Q.E.2 has been steady but hardly inspiring, and there are still fewer people working than there were before the credit crisis began in 2008. But consumer confidence has been rising recently and the stock market, despite some recent Fed-induced jitters, remains more than 30 percent above its level when the program began.

Floyd Norris comments on finance and the economy at nytimes.com/economix.

Article source: http://www.nytimes.com/2013/06/29/business/economy/dire-warnings-about-fed-strategy-did-not-come-to-pass.html?partner=rss&emc=rss

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Wealth Matters: Advisers Say Investors Are Slow to Overcome Anxiety

December 28, 2012 by Leave a Comment

But there were different kinds of uncertainty. To paraphrase Donald Rumsfeld, the former defense secretary, this year there were uncertain uncertainties and certain uncertainties. Some of the uncertain uncertainties were the European debt crisis, China’s handling of its stalled growth and leadership transition, and the presidential election in the United States.

The fiscal-cliff negotiations were a certain uncertainty. No one I spoke to throughout the year thought the talks would be concluded in a tidy fashion with weeks to spare, and they were certainly right.

“There has been a lot to worry about this year,” said Gregg Fisher, president and chief investment officer of Gerstein Fisher, a wealth management firm in New York. “The other problem with uncertainty is we’re worried about what other people are worried about. This creates huge amount of uncertainty without a path.”

Despite the worry, stocks in the United States had a good year, with the Standard Poor’s 500 up more than 12 percent even with the declines of the last week. More than that, Neeti Bhalla, head of tactical asset allocation at Goldman Sachs private wealth management, pointed out that this was the first year since 2009 in which the S. P. did not drop below its starting point for the year, 1,258.

“That was important because at no point this year did people feel a negative return in their equity portfolio,” Ms. Bhalla said. “You had pullbacks this year, but you never got to a negative experience.”

So what did investors do in a year that was full of uncertainty yet actually quite strong in terms of returns? The opposite of what they should have done: measurements of cash flows showed that investors took money out of equity funds while continuing to put money into fixed income, even though financial advisers were concerned that a slight drop in the price of bonds like Treasuries could quickly result in investors losing money.

“They were looking for stability in the fixed-income markets,” said Barbara Reinhard, chief investment strategist for Credit Suisse Private Bank. “The big thing is investors held onto the recent past and couldn’t get out of their own way.”

Of course, even the professionals would not fault the average investor for being scared by so much uncertainty. Chris Blum, global head of equities at J. P. Morgan Private Bank, said he liked to show clients a series of charts of stock returns over many decades. The trend is up despite periods of declines. But he knows that’s not enough to persuade them.

“I can show this kind of data in front of an individual 10 times until Sunday, but the reality is you’re not getting in touch with people who are scared,” he said. “You need to acknowledge how they feel. You can’t say markets are panicking, go buy.”

So how should investors have looked at this year? Much of the advice came down to two themes: the world won’t end, and politicians will eventually come up with a fiscal agreement. Still, advisers acknowledged that was deeply unsatisfying to clients. (I’d wager it may not have been worth the management fees that investors pay.)

Karen Wimbish, director of retail retirement at Wells Fargo, said she talked to investors about having three sources of income — guaranteed, stable and a pot of money that can grow over time. But she said the simplest solution for contentment in uncertain times was having a set plan.

“You don’t need $1 million to sit down and make a plan,” Ms. Wimbish said. “Retirement is a long-term proposition. If I’m in it for the long term and I’m saving, some years it is going to be up, some years it is going to be down. But over time, I’m going to be fine.”

Mr. Blum said he used data to try to get clients to the same place: while the year may have been bumpy, it was just one year among many.

“I comb the data on a chart to take them through what they’re feeling,” he said. “I ask them what concerns you about the fiscal cliff or what keeps you from deploying capital. I related those issues to what happens in risk assets and how those concerns get factored into the prices. But it’s not a slam dunk.”

Mr. Fisher said he tried to show clients that markets generally do a good job of factoring in risk.

“The return we expect to earn on stocks is higher when the risk we perceive is higher and lower when the risk we perceive is lower,” he said. “This is simple, but investors always seem to do the wrong thing.”

Article source: http://www.nytimes.com/2012/12/29/your-money/advisers-say-investors-are-slow-to-overcome-anxiety.html?partner=rss&emc=rss

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Economix Blog: The Fed vs. the Fiscal Cuts: Not a Fair Fight

December 12, 2012 by Leave a Comment

CATHERINE RAMPELL

CATHERINE RAMPELL

Dollars to doughnuts.

Since the financial crisis began, the Federal Reserve has taken the lead on stimulating the economy. It starting easing long before the Recovery Act was even a twinkle in Congress’s eye, and it has continued its stimulus efforts in the last couple of years to counteract fiscal tightening while the Recovery Act was petering out. As Mervyn A. King, the governor of the Bank of England, explained this week, central banks around the world have pursued monetary easing to offset fiscal tightening.

The problem is that fiscal tightening is now a much bigger potential negative for the economy than monetary easing is a positive.

The Fed announced today that it would provide more stimulus, by purchasing $45 billion in long-term Treasuries each month after its continuing “Operation Twist” concludes this month. This was welcome news to the markets, which have been clamoring for the Fed to do more, even though the marginal returns to more Fed stimulus get smaller and smaller. The first big injection of money into the economy does a lot; the second, not quite as much; the third, much less; and so on.

Meanwhile Congress is contemplating fiscal tightening that is much more potent than the Fed’s easing.

Forecasters have estimated that all the spending cuts and tax increases scheduled for the end of the year would shave around 3 to 3.5 percentage points from output growth next year. Few expect Congress to let this happen, of course.

Still, the policy compromise that many insiders do anticipate — eliminating most of the draconian spending cuts scheduled for 2013, extending the Bush-era tax cuts for all but the highest earners, and allowing the payroll tax holiday and emergency unemployment benefits to end as scheduled — will probably shave 2 to 2.5 percentage points off output growth early next year, according to Charles Dumas, chairman of Lombard Street Research. To put that in context, output growth for 2012 is shaping up to be only about 1.7 percent.

It’s no wonder that Ben S. Bernanke, the Fed chairman, has urged Congress to engage in more stimulus. More recently, he pleaded with them to at least not engage in the anti-stimulus that austerity measures amount to. The Fed has been going into overdrive, but even the most aggressive monetary policies are unlikely to reverse the output damage that severe fiscal tightening is expected to cause.

Article source: http://economix.blogs.nytimes.com/2012/12/12/the-fed-vs-the-fiscal-cuts-not-a-fair-fight/?partner=rss&emc=rss

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Opinion: The Dangerous Notion That Debt Doesn’t Matter

January 21, 2012 by Leave a Comment

Debt doesn’t matter? Really? That’s the most irresponsible fiscal notion since the tax-cutting mania brought on by the advent of supply-side economics. And it’s particularly problematic right now, as Congress resumes debating whether to extend the payroll-tax reduction or enact other stimulative measures.

Here’s the theory, in its most extreme configuration: To the extent that the government sells its debt to Americans (as opposed to foreigners), those obligations will disappear as aging folks who buy those Treasuries die off.

If that doesn’t seem to make much sense, don’t be puzzled — it doesn’t. Government borrowing is still debt that must eventually be paid off, just as we were taught in introductory economics.

Failing to repay the debt would mean not only the ugliness of default but also depriving the next generation of whatever savings their parents parked in government bonds.

And remember that just a small fraction of Treasuries are owned by individual Americans. Institutions and many foreign entities own the rest and are not about to give up claims that they are owed.

The more realistic alternative of continuing to service that debt offers the unattractive eventual prospect of either higher taxes or sharp cutbacks in government programs, or both.

That problem is greatly compounded by the fact that the $10 trillion of debt that is held by investors represents only a fraction of the federal government’s obligations and ignores an additional $46 trillion of commitments to Social Security and Medicare.

Of course every modern economy both tolerates and benefits from some amount of debt. But the United States has been on a binge, brought on by a toxic mix of spending increases and tax cuts that began with the Reagan tax cuts in the 1980s and were later turbocharged by those of President George W. Bush.

The figures are stark. In 1975, government debt per household was roughly equal to half of a typical household’s annual income. Today, it’s 1.7 times. Add entitlements, and the obligations would take a mind-boggling nine years of family income to pay off.

Even deficit hawks like me recognize that with the economy still barely above stall speed, now is hardly the moment for the government to slam on the fiscal brakes, debt or no debt.

So that means there’s no realistic alternative to more debt. But we can reduce the adverse consequences by how we spend this borrowed money. There are two main forms of stimulus: one kind is channeled through tax cuts and then mostly spent, just like a strapped family that puts its monthly expenses onto a credit card. Alternatively, government can direct its resources toward long-term investments that earn a return; think roads and dams but also medical research and education.

At the moment, gridlock grips Washington, and about all that Congress has offered is a two-month cut in the payroll tax, which may help shake the economy out of the doldrums but provides little lasting benefit.

We could just as effectively throw borrowed hundred-dollar bills out of airplanes. About the only worse approach would be nothing at all.

Government’s focus should shift toward investment. To do so, multiple challenges must be overcome.

First, unlike every company in America, the government doesn’t keep its books in a way that highlights these important two categories, investment and consumption. As a result, Congress can’t evaluate the long-term impact of its actions.

Second, the dark shadow of the Tea Party movement has made added spending — the route for most new government investment — taboo.

While public investment may take longer to unleash its positive forces, the case for it is compelling, in part because rising entitlement expenditures have crowded out government’s investment activities.

In the early 1950s, government devoted about 1.2 percent of gross domestic product to infrastructure; by 2010, that amount had fallen to just 0.2 percent. Meanwhile, federal spending on research and development dropped from a high of nearly 2 percent in 1964 to 0.9 percent in 2009.

By contrast, Franklin D. Roosevelt’s much-praised Works Progress Administration spent the equivalent of at least $1.5 trillion over eight years on projects that in New York City alone ranged from building La Guardia Airport to reroofing the New York Public Library to creating a lasting body of literary and artistic work.

I agree that short-term help for the economy combined with long-term deficit reduction is the right direction for budgetary policy.

But we also need to make every dollar of debt matter, and therefore we should be directing our efforts to lifting the economy toward programs that provide long-term benefit, not just a short-term burst of caffeinated energy.

A contributing opinion writer for The New York Times and a longtime Wall Street executive who was a counselor to the Treasury secretary.

Article source: http://feeds.nytimes.com/click.phdo?i=4dda30840ac296856b32dce77e9beef9

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Bucks Blog: Your 2012 Investment Plan

December 30, 2011 by Leave a Comment

Paul Sullivan, in his Wealth Matters column this week, goes back to a group of analysts and advisers who had agreed at the start of 2011 to not only make investment recommendations but also to assess each quarter how they were doing.

The one theme of the year is that no one could have anticipated all the economic shocks — from the earthquake and tsunami in Japan to the Arab revolutions and the economic and budget troubles in Europe and the United States. But, in some cases, the advisers made the right call, even if their reasons for the recommendation changed through the year. That was true for Bill Stone, of PNC Wealth Management, who backed dividend-paying stocks. On the other hand, none of the analysts anticipated the continued strong demand for United States Treasuries, even after Standard Poor’s downgraded the country’s credit rating in August.

So what’s their advice for 2012? In the wake of all the volatility in the markets in the second half of the year, the advisers say investors should tune out the daily headlines and concentrate on longer-term trends. Do you agree? What is your plan for investing in the new year?

Article source: http://feeds.nytimes.com/click.phdo?i=1b52aac3edb7145a9e149f254d6e5549

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Letters: Letters: The Reluctance to Invest

October 16, 2011 by Leave a Comment

To the Editor:

Re “Deer in the Headlights, Financially Speaking” (Economic View, Oct. 9), in which Richard H. Thaler saw a paralysis in the reluctance of individuals and businesses to invest during these uncertain times:

The column did not discuss an important point in regard to the business side of the issue: Businesses hoard cash at their own peril. Unless they are among the very largest companies, they are essentially setting themselves up for leveraged buyouts by corporate raiders who will swoop in, relieve them of their cash and leave the bones for the vultures to pick over.

This doesn’t serve the best interests of stockholders, and it doesn’t bode well for millions of Americans who are employed by these companies. Nothing will stop the gold rush once it commences. I’m surprised it hasn’t started already. Eric P. Jorve

Roseville, Minn., Oct. 10

To the Editor:

Richard H. Thaler wants both businesses and individuals to drop their fears of investing in the future  — even suggesting that Americans spend money now in home improvements instead of keeping savings in Treasuries or money market accounts. He also lamented a recent survey in which many companies said they were waiting for economic uncertainty to decline before deploying their huge piles of cash.

Has he dismissed a possibility that many planners, treasurers and wealthier households are considering? After the plunge in stock prices during the summer, everyone seems to be worried about long-term high unemployment, lower wages and benefit cuts. So it is possible, if not likely, that the general price level will fall, or at least not rise so much as to make a delay in investing look unwise.

There is a term for this possible state of affairs. It is not paralysis, and it is not inaction. It’s deflation. Savita A. SahayShort Hills, N.J., Oct. 9

The Art of Food Ads

To the Editor:

“Grilled Chicken, That Temperamental Star” (Oct. 9), which examined the practice of tabletop directing for food commercials, hit home with me.

After years working as a prop person for various masters of the art, I wrote a play called “Tabletop” that won the 2001 Drama Desk award for best ensemble performance.

Theater asks an audience to identify with characters who in some sense feel as if their lives are at stake. While one may question many aspects of television commercials, there’s no doubt about the skill and determination of the people who create them or their importance to capitalist culture.

As an idealistic assistant observes in my play: “In the 13th century, we’d be carving gargoyles on a Gothic cathedral. Well, we don’t make such valuable stuff anymore. But at least we make memorable images.”

Rob Ackerman

Manhattan, Oct. 9

Letters for Sunday Business may be sent to sunbiz@nytimes.com

Article source: http://feeds.nytimes.com/click.phdo?i=ae2ea0d4c9d88ef64dc49717ac22f05e

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Almost Out of Tricks, Fed May Train Sights on Longer-Term Rates

September 3, 2011 by Leave a Comment

Cheaper credit could give the economy a boost — and prompt more hiring — by encouraging more borrowing, so companies and consumers have more money to spend. But with interest rates already low, it isn’t certain how much this might help the economy, though proponents of more action by the Fed argue that this is better than not trying.

The central bank has already undertaken a spate of unprecedented measures to reinvigorate growth, including two large rounds of asset purchases. At its August meeting, many Fed policy makers expressed interest in engaging in further easing measures, but could not agree what to do.

This dismal job report may spur them to action.

“I just don’t think the Fed will sit idly as momentum fizzles in this recovery,” said Dana Saporta, a United States economist at Credit Suisse. “We fully expect some more action from the committee later this month.”

The Fed is running low on ammunition, though, and given political attacks on its accommodative measures thus far, its options are especially constrained.

As a result, economists predict that the Fed will change the composition of the assets on its balance sheet, instead of expanding its size as it has in the past. Right now the Federal Reserve holds about $1.7 trillion in United States Treasury securities, of a vast array. Some mature in a few days, and others in more than 10 years. Many economists are guessing that the central bank will start selling off the ones that mature soon, and buying up more Treasuries that mature later.

Buying more longer-term Treasuries increases the demand for longer-term issues. And as their prices rise, the interest rates on those securities fall, as do many other interest rates across the economy that are pegged to the Treasury rate.

In addition to stimulating the economy with cheaper credit, lower long-term interest rates could encourage investment in riskier assets, like stocks. After all, if 10-year Treasuries don’t offer much in the way of returns, investors will seek higher returns elsewhere. If investors do start buying up riskier assets, those asset prices rise. Consumers then see that their portfolios are worth more, causing them to feel richer and so more comfortable with spending. This is known as the wealth effect.

There are limits to how aggressive the Fed can be in swapping out short-term securities for longer-term ones. If it sells too many shorter term notes, then short-term interest rates will rise, and the Fed has already promised markets that it will keep short-term rates near zero for the next two years.

Plus, after two rounds of quantitative easing and a worldwide flight to safety, longer term interest rates are already at historical lows of about 2 percent. It is not clear that lowering them further would do much to encourage more investment in riskier assets, or to increase lending.

“The cost of borrowing is not the problem,” said Paul Ashworth, chief United States economist at Capital Economics. “The problem is that there are not creditworthy borrowers, and that businesses don’t want to invest because they’re concerned about the economic outlook.”

Additionally, if investors do start increasing their investments in assets with higher returns, they may pour more money into commodities like oil. And commodity prices are already higher today than they were a year ago; pushing energy and food prices further up could actually discourage consumers from spending.

Other options that Fed might consider include lowering the interest rate it pays banks on excess reserves to encourage them to lend more, but many economists doubt that this would have substantial effects on growth. A more aggressive option would be to raise its medium-term target for inflation.

If prices are expected to rise, banks, businesses and consumers will be more eager to spend their money before it loses value. That could have positive effects throughout the economy, since spending means more demand for goods and services, which means companies need to hire more employees, which means more spending, and so on.

Additionally, inflation would lower the value of many people’s debt burdens and so help with the painful process of deleveraging.

The problem, though, is that inflation has some major downsides, too — especially if coupled with sluggish growth, as seen during the “stagflation” of the 1970s. Not having a good sense of how much your next gallon of milk or gas will cost is stressful, particularly if your wages aren’t rising to match the higher prices. And some economists contend that raising inflation would only defer, not eliminate, the nation’s problems.

“People who say we should get the inflation rate up to 5 percent forget that there’s a second half of that policy: bringing it back down again,” said Allan H. Meltzer, an economics professor at Carnegie Mellon and a Fed historian. “Raising it, that’s the fun part. Lowering it, that’s the painful part. At some time in the future you’re going to have that pain. Why is it better later than now?”

Mr. Meltzer, like many other economists, argues that any further Fed actions will have little effect on the economy.

Even Ben S. Bernanke, the Federal Reserve chairman, stated in a speech last week that most of the tools that could be used to increase growth are “outside the province of the central bank.”

In other words, said Ms. Saporta, “the Fed is putting the ball back in Congress’s court.”

Article source: http://feeds.nytimes.com/click.phdo?i=f273782ed1933de8bcb063111b7289c4

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Markets Will Look for Hints in Bernanke’s Words

August 24, 2011 by Leave a Comment

It was just a year ago, after all, that the economy was in almost exactly the same position: pitifully slow job and output growth, fears about another financial shock from Europe’s debt crisis, warnings of a double-dip recession. And a year ago, at this same conference, the chairman, Ben S. Bernanke, pointedly described all the weapons the Fed had available to rescue the economy — you know, just in case.

Several months later, the Fed opened its arsenal and began a major asset-purchasing program intended to stimulate growth.

Given Congress’s unwillingness to engage in more fiscal stimulus — in fact, it plans to pull back on spending — analysts and investors are wondering whether history will repeat itself, especially if the economy deteriorates further. Stock markets have been rallying this week, partly on hopes that Mr. Bernanke may signal more monetary stimulus is on the way, or at least under what conditions more stimulus would be likely. Broad stock indexes gained 3 percent or more on Tuesday, with the Dow industrial average pushing back above 11,000.

Among the options Mr. Bernanke is expected to lay out on Friday would be engaging in another round of major asset purchases, known as quantitative easing, which is meant to lower long-term interest rates; lowering the interest rate the Federal Reserve pays banks on their reserves; and extending the maturity structure of the Fed’s current portfolio of Treasuries, which analysts expect to be the most likely course of action. All these potential strategies would be intended to encourage more lending, among other goals, and thereby increase growth. The Fed might also raise its medium-term target for inflation, which would discourage banks, businesses and consumers from sitting on their cash, and so induce them to spend more.

But beyond such potential options, the announcement of a clear monetary policy road map seems unlikely. Fed speeches are constructed to cause minimal market excitement — either good or bad — and there are reasons to think Mr. Bernanke’s speech may be especially noncommittal.

First, only two weeks ago the board’s Federal Open Market Committee, which sets benchmarks on interest rates, severely dimmed its economic forecasts and took the unusual step of pledging to keep short-term interest rates near zero through at least mid-2013. It seems unlikely that the Fed would make major news so soon after that announcement, economists say.

“I don’t think the picture has changed all that much from two weeks ago,” said Paul Dales, senior United States economist at Capital Economics. “Suggesting more is in the pipeline already would smack of panic.”

Moreover, Mr. Bernanke could not unilaterally make a major policy change; he would need to seek approval from other Fed officials. Such consensus has become more challenging, since the composition of voting members on the Federal Open Market Committee has changed since last year.

Last year there was one steady dissenter, the Federal Reserve Bank of Kansas City president, Thomas M. Hoenig. Mr. Hoenig consistently voted against keeping short-term interest rates near zero for so long, and voted against the second round of quantitative easing begun by the Fed last November.

The voting members of the committee rotate each year, and now there is not one but three strongly hawkish voices: Narayana Kocherlakota, Charles I. Plosser and Richard W. Fisher, who are the presidents of the Federal Reserve Banks of Minneapolis, Philadelphia and Dallas, respectively. These three voted against the Aug. 9 announcement keeping short-term interest rates low through mid-2013, and so seem unlikely to endorse further easing measures.

There is also mounting political pressure from outside the Fed — on Capitol Hill and the presidential campaign trail — against expanding the central bank’s balance sheet.

Another reason Mr. Bernanke may be especially reluctant to signal commitment to further monetary stimulus is that inflation has picked up. Monetary stimulus, after all, generally increases inflation since it pumps more money into the economy and chases prices higher.

Last year, when economists gathered at Jackson Hole, the most recent consumer price index report had shown prices to have risen over the previous year by 1.2 percent. With inflation so low — and below the Fed’s target rate of inflation — many economists worried that the country could descend into a deflationary spiral akin to the one seen during the Great Depression, and more recently in Japan. With the threat of deflation, another round of quantitative easing seemed prudent, or at least less risky.

Today, though, consumer prices are 3.6 percent higher than a year ago, softening the case for further monetary stimulus. The Fed has a dual mandate, maximum employment and stable prices; even if Fed policy makers believe further easing might help employment, they may be reluctant to compromise the other half of their mandate.

The final reason Mr. Bernanke may be reluctant to go further is that it is not clear how powerful more monetary stimulus would be. And it is not just anti-Fed types like the presidential candidate Rick Perry who doubt the usefulness of more easing; Ph.D. economists are skeptical too.

“At this point you’re really pushing on a string,” said Nigel Gault, chief United States economist at IHS Global Insight.

Economists are still debating the effectiveness of the quantitative easing program begun last November, raising questions about the potency of yet more asset purchases.

Quantitative easing is supposed to help lending (and thereby growth) by pushing down long-term interest rates, which are already quite low. It is not clear that lowering them further would do much to encourage lending, especially since many companies do not see a need to borrow primarily because demand is so weak, and not because credit is expensive.

The other way that quantitative easing is intended to help spur growth is by encouraging investment in riskier assets, like stocks, because the return is so low on long-term Treasuries. If investors flee to these assets — as they did last year, following the Jackson Hole speech — that could raise the price of these assets, causing consumers to feel richer and so more comfortable with spending.

Commodity prices are higher today than they were a year ago, though, and policy makers may worry about pushing them even further up. If energy and food prices rise again, that would actually discourage consumers from spending.

For these reasons, many economists say they believe that, should the Fed engage in more stimulus, it will be unlikely to select quantitative easing as its weapon. But the other options, too, present their own hurdles, and many are still untested.

In the end, economists say, any additional Fed action may depend on what seems most politically palatable, even though the central bank is officially an independent entity. And that logic seems to point to changing the maturity of the assets on the Fed’s balance sheet.

Article source: http://www.nytimes.com/2011/08/24/business/markets-will-look-for-hints-in-bernankes-words.html?partner=rss&emc=rss

Filed Under: Global Business Tagged With: , ,

Hopeful, but Wary at Money Markets

August 1, 2011 by Leave a Comment

In search of safer havens, investors have flocked to newer investments like federally guaranteed, zero-interest checking accounts. Fund managers, in turn, have increased cash levels and shifted their portfolios to hold even more investments that can be easily sold to meet investor withdrawals.

Congress was working around the clock over the weekend to raise the debt ceiling by Tuesday, reaching a framework agreement late Sunday. But even a short-term Congressional deal will leave some uncertainty for money market investors.

One credit rating agency has held out the possibility that it would downgrade in the nation’s credit rating even with a debt deal in place. Such a move would probably send even more investors toward the exits, fearful that fund managers will have to decide whether to sell off other holdings whose value could be affected by lower ratings.

But the greatest fear for a fund manager is that a fund “breaks the buck” — that its share value falls below the stable $1-a-share price that money funds maintain. That happened in 2008, when the asset value of the Reserve Primary fund fell to 97 cents a share because of its large holdings of the debt of Lehman Brothers, which went bankrupt.

To break the buck, its value must fall by one-half of 1 percent, to 99.5 cents a share. Since Treasury bond prices move inversely with interest rates, if the market attaches greater risk to owning Treasuries, their interest rates would rise and prices would fall to attract buyers. A steep swing in rates and prices could cause the value of a money market fund to sink below the $1 level.

Chris Plantier, a senior economist at the Investment Company Institute, a mutual fund trade group, and Sean Collins, a senior director of industry and financial analysis, said last week that their models showed that it would take a 3 percentage point rise in short-term interest rates, affecting every security in a money market fund’s portfolio, to drive a fund’s value down to 99.5 cents a share.

With short-term rates currently near zero, a jump of 3 percentage points would be such a catastrophic event that money funds might be the least of investors’ problems. It’s so inconceivable that rates for consumers and businesses could jump that far that fast that it evokes dire images of people in bread lines.

More likely, managers say, is that a downgrade of Treasury bond ratings would push short-term rates up by one-quarter to three-quarters of a point, leaving the net asset value of money funds safely at $1 a share.

Over all, though, fund managers and regulators were optimistic that money market funds would be relatively untouched by further market turmoil.

“We’ve had a contingency team focused on this since the end of May,” Robert Brown, president of money markets at Fidelity Investments, the nation’s largest manager of money market funds, said Friday. “We have to be prepared to respond to the unthinkable.”

Fidelity has $440 billion in money market fund assets.

Federal regulators, too, say they believe that investors have seen what is possible — unlike in 2008, when Lehman Brothers went bankrupt over a weekend.

“I don’t believe the Treasury markets are going to freeze up,” said one federal regulator, who spoke on the condition of anonymity because he feared the knowledge that regulators were watching might cause undue concern about a market segment. “The funds we have talked to are well positioned to substantially handle the kinds of outflows that they have seen recently.”

Money funds must hold only highly rated, short-term assets, but government securities are exempt from the requirement. So a ratings downgrade would not automatically force fund managers to sell Treasuries.

The greater danger is to money funds with extensive holdings of short-term corporate i.o.u.’s, or commercial paper. Any issuer that enjoys a high credit rating because of implicit or explicit support from the government could be subject to downgrades if the government’s rating fell.

Those include Fannie Mae, one of the big government mortgage companies, whose debts are guaranteed by Washington but which would likely be downgraded as well, and some of the largest banks, which might enjoy an implicit belief that the government would bail them out in a financial crisis, as it did in 2008.

Regulations after 2008 require taxable money market funds to hold 10 percent of their assets in a form that can be converted to cash in a single day, and all funds to hold 30 percent of assets in a form that can be converted to cash within five days.

According to one market analyst, iMoneyNet, many funds have gone beyond that. On June 30, the company said, the average government money market fund had 58 percent of its assets in securities that would mature within five days.

Even so, the next-to-nothing interest rates that most money market funds are currently earning have been judged by many investors not to be worth the risk. A little-noticed portion of the Dodd-Frank Act, passed in the wake of the financial crisis, provides federal insurance through the end of 2012 for unlimited amounts of deposits in noninterest-bearing checking accounts.

That has led to a sharp upswing in the assets in bank checking accounts, to $2.4 trillion at the end of last year from $2.1 trillion at the end of 2009.

So far, it doesn’t seem to have worried investors that the government that is promising to make interest payments on Treasuries is the same government insuring those checking accounts. Insurance on bank accounts is covered by the Federal Deposit Insurance Corporation.

Article source: http://feeds.nytimes.com/click.phdo?i=04771de64edc271ff34896ec6201297f

Filed Under: Business News Tagged With: , ,
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