Thursday, March 20, 2014

The March FOMC Decision

by Pater Tenebrarum

Convoluted Statement Becomes More So

As always, Kremlinologists can check the WSJ's trusty FOMC statement tracker to see what has actually changed. Ever since the first 'taper' announcement in December, the statement has become a lot more convoluted. As far as we can tell, the reason for this is that there is a plan underway to slowly replace actual money printing with something called 'forward guidance'. This consists of promises about the future conduct of policy that are worth precisely nothing, since the Fed can definitely not see the future. Not only are there no trained fortune tellers in its employ, but what insights into the future state of the economy it tends to offer have a well-worn record of being worse than a coin flip, especially near economic turning points.

This is not necessarily a complaint, mind. One cannot fault people for their inability to correctly anticipate the future, least of all bureaucrats. If they were able to make correct forecasts, they wouldn't be bureaucrats, but businessmen or speculators.  In that sense, 'forward guidance' is a waste of ink. In fact, the statement itself indicates as much:

“In determining how long to maintain the current 0 to 1/4 percent target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including  measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee continues to anticipate, based on its assessment of these factors, that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee's 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

(emphasis added)

Incidentally, the above excerpt used to include the 6.5% unemployment threshold, which has now been removed  – in other words,  from 'fixed targets' it's now back to 'we'll make it up as we go along'. Of course neither one nor the other is going to improve the insight of the central planners regarding the 'correct' height of interest rates.

The sentences highlighted above meanwhile show that the whole 'forward guidance' spiel is really useless, as it requires generous garnishing with so many qualifiers that it would be just as well not to say anything at all.

The only really important information was actually that the 'tapering' of 'QE 3' will continue. The monthly pace of debt monetization will thus decline by $10 billion to $55 billion ($25 bn. MBS, $30 bn. treasuries).

Interestingly, Narayana Kocherlakota dissented because he thought the 5th paragraph of the statement didn't make sufficiently clear that the Fed is committed to increasing the 'rate of inflation' to its nonsensical 'target' of 2% (allegedly, 'inflation' is currently 'too low').

Markets Balk

Later, Ms. Yellen gave her first press conference and promptly managed to 'disappoint' the boys on Wall Street by saying something that was not deliberately shrouded in obfuscatory language.

According to Bloomberg/Business Week, she committed the unforgivable  'rookie mistake' of 'speaking too clearly':

“At her first press conference  since becoming Fed chair in February, Yellen was asked what the Fed meant by “a considerable time.” The correct answer to this question is, “We weren’t specific for a reason. Go away.” Yellen, having been connected with the Fed in one capacity or another for most of the past 20 years, should have known that. Instead, she said, “You know, this is the kind of term it’s hard to define, but, you know, it probably means something on the order of around six months or that type of thing.” That was a bit quicker than markets had been expecting, so interest rates rose and stocks fell .

The comment “sent equity markets into something of a tailspin,” wrote Paul Ashworth of Capital Economics. Michael Wallace of Action Economics in Colorado called Yellen’s specificity a “gaffe.” He wrote that Yellen made “the mistake of ‘taking the bait’ and providing a time reference for the purposefully ambiguous phrase.” It wasn’t the only factor in the market sell-off today—new economic projections by members of the FOMC were also a factor—but it did make a difference.”

(emphasis added)

How dare she not stay mysterious and inscrutable? Where are we going to end up if the price fixers at the Fed begin to give concrete answers to concrete questions? What a calamity!

The incident is in a sense revealing with respect to the absurdity of the rituals surrounding what it is in the end not much more than a pretty straightforward wealth redistribution (a.k.a. 'theft') and bubble-blowing operation. An operation that is different from the coin clipping of kings of yore only in terms of its arrogant pretenses to being 'scientific'.

Interestingly, apart from the US dollar, no market liked the statement or the press conference. In other words, markets saw the action as 'hawkish', whatever that means in light of $55 bn. of ongoing debt monetization and an overnight lending rate of zilch. However, things are of course relative – once an asset and credit bubble has been blown up to such astounding proportions as the current one, all it takes to upset it is a sufficient slowdown in monetary expansion, so in that sense market participants were probably correct in being displeased (more on this further below).

Gold continued its recent decline, but as this article at Zerohedge points out,  that is actually quite normal during FOMC week. Treasury bonds and stocks sold off as well.

gold, one weekGold (April future, 30 min. candles) continued its recent correction on FOMC day. Note that the metal is now approaching an important area of support that should ideally hold to keep this year's bullish tone intact. The weak seasonal period is beginning and it will be interesting to see how the gold market handles it (seasonal tendencies didn't mean much in the past three years or so) – click to enlarge.

TNX-10 min

10 year treasury note yield, 10 min. chart.  A pretty strong move in yields for one day – click to enlarge.

SPX, 10 min. chart. The stock market disliked the statement as well, although it  probably remains the most bullet-proof market for now relatively speaking – click to enlarge.

Dollar Index, 30 min
US dollar index, 30 min. chart: the one and only market that actually liked the FOMC song and dance on Wednesday – click to enlarge.

Money Supply

Due to the ongoing, if somewhat slower, debt monetization program, the monetary base continues to increase. However, the broad money supply TMS-2 actually suffered a rare decline in January (the most recent period for which the data are available), falling from $9.978 trillion to $9.972 trillion, i.e., a decline of a little over  $6 billion. What precisely was to blame for that we are not certain, but one guess is that European banks are busy shifting funds around.

The recently published quarterly BIS report included a chapter dealing with deposit fund flows from euro area banks the US branches of which hold large excess reserves with the Fed. Some of these flows were tied to a risk-free carry trade by banks not subject to FDIC fees by using reserves, on which the Fed pays 25 bps interest. Apparently some of the associated flows are about to reverse with the increased employment of reverse repos by the Fed. In the course of the euro area debt crisis, we have already seen that dollar flows from and to Europe can have a fairly large effect on US domestic money supply growth. Dollar deposits held in offshore accounts won't show up in the domestic data, and given continued QE and positive loan growth in the US, a decline in the broad money supply can only mean that some money has actually flown out. Note also that there may be seasonal effects at work – in any event, one month is not necessarily meaningful in this context.

Monetary Base
The US monetary base continues to grow in line with 'QE' debt monetization – click to enlarge.


Broad US money supply TMS-2 has slightly declined in January – click to enlarge.

The decline could just be a small blip that is soon reversed again. The most important feature to keep an eye on is the year-on-year growth rate of TMS-2, which has been declining since the end of the 'QE2'. This decline in the growth rate seems likely to continue in coming months in view of the 'taper'.


The Fed continues to subtly tighten monetary policy, even though it is far from 'tight' – it is merely slightly less loose than it used to be. At some point the markets that have benefited the most from monetary pumping in recent years are likely to balk for more than just one day. Credit markets strike us as especially vulnerable to a potential set-up, specifically markets that offer such low returns by now that there is no margin of error left, and which have seen record issuance volumes, such as junk bonds (which are increasingly bereft of loan covenants protecting investors).

We have of course no idea at the moment what precisely will precipitate the next financial accident, but the more money supply growth slows down, the more likely such an accident will become. The precise trigger event doesn't really matter actually – once the time is ripe, any excuse will do.

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