3 points on the Fed minutes

*  It was interesting (and kind of disappointing) that the Fed didn't provide any discussion of the implementation of lifting rates off of zero.  As has been discussed here and elsewhere, thanks to the Everest of excess reserves, the mechanism for raising rates is a little more complicated than simply specifying a target range for Fed funds and adding/draining liquidity.   It seems pretty clear that IOER will be used to ensure a ceiling for the target range that banks will use to park excess reserves; the trouble comes from the GSEs, who have access to the Fed funds market but not IOER.   The Fed will likely use a reverse repo facility that the GSEs and money market funds can access, but as of yet, we still have no idea a) if it will be a "your amount" facility, or b) what the spread will be to IOER and the FF target.  It's kind of crazy when you think about it, but if the RRP spread is wide enough, the Fed could conceivably raise rates without actually raising rates.  A little clarity on their intent would not have gone amiss.


* The dovish wing of the committee is talking themselves into a bit of a catch-22 when it comes to normalizing policy.  "They also noted uncertainty about whether economic growth was robust enough to withstand potential adverse shocks, given the limited ability of monetary policy to offset such shocks when the federal funds rate is near its effective lower bound, and concern that the beginning of policy normalization might be associated with an unwarranted tightening of financial conditions."  In other words, with rates at zero, you cannot move the policy rate any higher because if something goes wrong, rates are too close to zero to generate an effective easing.   In addition to casting a subtle aspersion on the efficacy of QE, this line of thinking also suggests that ZIRP is like the event horizon of some sort of monetary black hole; once you enter, you can never leave.  Actually, the empirical evidence to date would appear to back that up....

* The initial part of the minutes summarized a discussion on a staff presentation on the equilibrium real interest rate, a subject Macro Man touched on a few weeks ago.  While the conclusion was understandably that the equilibrium rate was lower than it used to be, Macro Man was struck by this:

In their comments on the briefings and in their discussion of the potential use of r* in monetary policy deliberations, policymakers made a number of observations. The unemployment rate has declined gradually in recent years, indicating that real gross domestic product (GDP) growth has, on average, exceeded growth of potential GDP, but not by a substantial margin. This outcome, in turn, suggested that the actual level of short-term real interest rates has been below but not substantially below the equilibrium real rate, consistent with estimates that r* currently is close to zero...

So the edifice of the argument that the equilibrium real rate is zero is that unemployment has only declined "gradually" over the past few years?   Sure, unemployment has declined more slowly than it increased, but that's the case in almost all recessions and recoveries.   Let's put the recent decline in unemployment into context.   Here's a chart of the rolling 5 year change in unemployment since the 1950's:


As you can see, the 5 year decline in the unemployment rate is unmatched in history, except for the go-go 1980's.  The current percentile is just 1.2%.  OK, you say, but that's coming from an unnaturally high base thanks to the Great Recession; what if we look at a more recent time frame?   Here's the same indicator, but with a rolling 2 year change:


That's much less impressive; we're all the way up to the 2.4% percentile, and only the joint second fastest 2 year decline since the 1950's.  Gradual indeed.   If we look at the 1 year change in unemployment, what do we find?

From that perspective, it's a more middle-of-the-road decline in unemployment....but we've still seen the fastest decline in 30 years, though things have decelerated a bit since then.  Even so, we're still in the 21% percentile, which is pretty solid when we're so close to NAIRU.

By just about any definition, the decline in unemployment during the recovery has been faster than normal, even accounting for the high starting point.   Sorry, Fed.   You're entitled to your own opinions.   You're entitled to your own models.   You're not entitled to your own facts.

Finally, Macro Man doesn't really do "hot tips" for short term trades, but if he did, today's would probably be to buy silver.   Argent declined for fourteen consecutive days including yesterday, smashing the previous record of ten set during the financial crisis.  The loss of downside impetus over the last several days was notable, and yesterday's doji candle could represent something of a turning point.  It's notable that the RSI has already hooked higher at the first sniff of a rally, and it really wouldn't be surprising to see a 50c -75c pop from here just to kick a few of the latecomers to the selling party squarely in the groin.


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Anonymous
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November 19, 2015 at 12:06 PM ×

Thanks for this MM.

Do you know of a decent (and relatively modern) Primer on the mechanics of central bank policy in the US? Particularly how it contrasts to the UK if possible

Struggling to keep up despite reading your previous posts on the topic!

Many thanks

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washedup
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November 19, 2015 at 3:13 PM ×

MM - good catch on the unemployment rate slope - in their defense, perhaps they are focused on U6 being much higher and coming down more slowly.

Oh who am I defending - it should be pretty obvious that the most powerful college professors in the world have lost the plot and thats its all about 'financial conditions'.

This ends with all academic pretenses coming off in the next decade with the US federal reserve owning 75% of the NYSE composite with a guaranteed 6% annual return.

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Mr. T
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November 19, 2015 at 5:25 PM ×

I understand that IOER is the apparent policy direction, but as a tool it seems just downright awful. Consider excess reserves as a sort of potential energy for inflation (I think everyone would agree that if the current ~$3T went chasing returns in the markets it would generate a substantial amount of inflation). If the fed wants higher inflation, why on earth would they be encouraging greater reserves? I must be missing something. I would think they would want to be trying to drain reserves, or at least disincentive banks from sitting on enormous piles of cash. People talk about M2 velocity being a cause of low inflation, well here is a great source of it. M2 velocity vs Reserves The economy is nowhere near overheating.

Call me cynical, but lets call a spade a spade. This works great for the big banks who want higher returns on their capital without any market risk. This goes beyond regulatory capture imho. If anyone outside of finance wonks understood what IOER implied I don't think it would last through the weekend.

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Anonymous
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November 19, 2015 at 5:29 PM ×

This is good for liftoff mechanics. From Credit Suisse. Thanks for the blog.

https://doc.research-and-analytics.csfb.com/docView?sourceid=em&document_id=x654083&serialid=2TXEgOGercjFbPp2zWo1mAcl0LF%2FhzlqIWMsoyTFCE4%3D

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Macro Man
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November 19, 2015 at 6:28 PM ×

@ Mr. T: The problem with draining reserves is that they'd need to sell ~$2.5 trillion worth of securities to do so. It's not hard to appreciate the reticence to do that. As for IOER, it is unfortunately a product of the Fed's policy mechanism. If they targeted a fixed repo rate rather than a floating Fed funds rate, there would be no need for IOER; unfortunately, that's not the case. I'd prefer a European -style corridor system with a depo rate below the main policy rate, and an emergency lending rate above it (which we already have- the discount rate.) Unfortunately, to maintain FF at target the Fed needs to neutralize the effect of XS reserves...hence IOER.

@ Anon, thanks for the CS note. Posznar is the man when it comes to plumbing, though I'd be slightly sceptical that he has any special insight (ie inside info) other than informed opinion. I'd agree though that full allotment RRP makes sense, especially for the initial liftoff.

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washedup
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November 19, 2015 at 6:40 PM ×

anon 5:29 - many thx for that note - always liked sweeney's stuff in a previous life.

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Mr. T
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November 19, 2015 at 6:59 PM ×

Why would the entire 2.5T needs to be drained? I see that FFR mechanism is hamstrung by higher reserves but wouldn't anti-QE of a gradual but consistent balance sheet reduction have a tightening effect? Using the size of balance sheet as a policy tool shouldn't be a one way street imho.

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abee crombie
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November 19, 2015 at 7:11 PM ×

Its seems pretty apparent to me that with QE tools to be the choice of major central banks for the near future, monetary policy will need to adapt, just like it always had, from discounting bills in the early fed days, to targeting M2 and more recently the Fed Fund rate. I'm sure there will be bumps along the way but I do think monetary policy will evolve just like it always had. Mr T, I dont see the huge problem with IOER the Fed will just have to play a different game. And I would assume that come the next downturn their balance sheet will expand even larger before they get a chance to run it off. Probably something close to Japan, and maybe even washedup's version.

Currencies bouncing, so when will oil (and copper)?

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washedup
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November 19, 2015 at 7:39 PM ×

@T - you are , with all due respect, missing the entire point - this is the fed's way of being able to point to a rate increase while not exactly 'tightening' financial conditions - hence the jumping through hoops, the 'freezing' vs 'draining', and the acronym soup.

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Thought4TheDay
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November 19, 2015 at 10:09 PM ×

Central Banks Fight to Ensure Crisis Tools Become the Norm:

http://www.bloomberg.com/news/articles/2015-11-19/central-banks-fight-to-ensure-crisis-toolkits-become-the-norm

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EschewObfuscation
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November 20, 2015 at 12:44 AM ×

IOER is where the Fed literally creates money and hands it to rich people, right? And the richer they are, the more new money they get?

I cannot imagine why anyone would object.

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Anonymous
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November 20, 2015 at 4:21 AM ×

http://www.bloomberg.com/news/articles/2015-11-19/china-has-a-1-2-trillion-ponzi-finance-problem-as-debt-piles-up

wow BBRG reporters might have airport delays while travelling into china........

I AM A ROBOT

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Anonymous
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November 20, 2015 at 5:09 AM ×

http://www.bloomberg.com/news/articles/2015-11-20/china-cracks-64-billion-underground-bank-moving-money-abroad

China said it cracked the nation’s biggest “underground bank,” which handled $64 billion of illegal foreign-exchange transactions, as the nation tries to combat corruption and rein in capital outflows that have hit records this year. More than 370 people have been arrested or face lawsuits or other punishment in the case centered in eastern Zhejiang province. The case brought the total for underground banking and money-laundering activities to $125 billion since April.

What could possibly go wrong? Or, how bad could it possibly get?

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Anonymous
admin
November 20, 2015 at 6:17 AM ×

http://www.bloomberg.com/news/articles/2015-11-19/a-hard-landing-in-china-could-shake-the-world-


pretty bad....


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Anonymous
admin
November 20, 2015 at 6:21 AM ×

Especially if you are Chinese and You have invested in Wealth (Management)DeStruction Products

someone famous once said China was 1 day away for unstability.. WMP are a time bomb, fuse is set cant be unlit...
but I have said this same thing about china on this forum before WMP is the undoing as the middle class lose their wealth.....

Welcome to wall street suckers


I AM AN ALGO

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