Central bank credibility

The RBA left rates unchanged last night, much as Macro Man expected.   The statement was fairly balanced, acknowledging both the modest improvement in economic activity and the ability to trim rates further should circumstances warrant.  Clearly some in the market were looking for cuts, given the decent squeeze in the AUD at the time of writing.   The RBA appears willing to be guided by the evolution of the economy without rushing to judgement over short-term developments....a decidedly credible approach.

For many years, the idea of central bank credibility revolved around an institution's ability and willingness to meet some sort of policy goal, normally around inflation.  Indeed, the whole notion of inflation targeting evolved as a means of enshrining a central bank's credibility into the public consciousness.

Latterly, of course, traditional central bank credibility has come under scrutiny both because of the failure to achieve published inflation targets (though unusually in the free-floating fiat currency era, it's been the failure to get inflation high enough) and for the nature of the nontraditional policy tools that have been employed, most notably QE and forward guidance.

However, in an environment of heightened regulatory intervention into many long-standing private-sector market practices, it's important to focus on other aspects of central bank credibility.  We operate in an environment of caprice when it comes to overseers' attitudes to market participants; some murky practices of dubious ethical legitimacy are permitted, seemingly because they are simply difficult to explain, whereas other, simpler activities  have become frowned upon by various members of the alphabet soup regulatory regime.  Moreover, regulatory credibility suffers substantially in cases such as blaming the Flash Crash on a relatively small futures trader living in his parents' house near Heathrow Airport.   Really?  It was him that told some robot to sell Accenture at a penny, and then handed said robot a Get Out of Jail Free card by wiping the trade?

In any event, when private sector participants are being targeted with what seems to be a fair amount of randomness, it is incumbent upon central banks to be whiter than white, paragons of virtue.   Not only because they are, after all, civil servants obliged to act in the public's best interest, but also because modern central banking revolves so heavily around communication.  In this, a number of central banks have been found wanting over the last few years:

* Philipp Hildebrand's wife made a tidy profit shorting the CHF just before the SNB imposed the EUR/CHF floor.  Really?   The SNB President's wife is allowed to punt instruments traded by her husband?

* Fed leaks.  Although the Federal Reserve is in the dock for a specific leak to MGA three years ago, anyone who's been around the block is aware of the myriad of consultancies who get messages on the QT from various members of the FOMC.  Macro Man can recall chatting with a punter friend at a well-known shop in early March 2009 and being told "we hear they're going to do QE."  Sure enough, that month, the Fed inaugurated its first proper QE program, and his friend (and the shop) made a killing.  Regulators have cracked down on this type of behaviour in the private sector, which is all the more reason for the Fed to keep their gobs shut.

* ECB meeting with the market just before policy announcements.   The FT has a story up about how a number of ECB members met with banks and buyside shops just before major policy announcements and during negotiations of to keep Greece afloat.  And of course, Benoit Coure was kind enough to tell a dinner full of punters how the ECB planned to execute QE the night before Draghi told everyone else in May.

* Mark Carney has wasted few opportunities to rail against pay in the banking sector, market practices, etc.   It's quite a turnaround for him, as he showed little interest in limiting bankers' pay when it came to negotiating his own compensation package, which at £874k per annum dwarfs not only his predecessor's remuneration, but that of every other major central bank chief in the world.  And what has the UK received for this expensive hypocrisy?   As many policy moves as an untrained chimpanzee could have executed over the same period, with more waffles than a Belgian bakery.



Listen, we get it: nobody's perfect.  But when the most charitable explanation for certain policymakers' behaviour is "stupid and naive", particularly if and as the behaviour provides certain advantages to select market participants.....well, that really shouldn't be allowed to fly given some of the things that private sector guys have been hung out to dry for.

Speaking of not being allowed to fly, if you're an SPX bear you could hardly ask for a better set-up to go short.   The index back towards all-time highs, earnings largely out of the way, macro data continuing to disappoint...and oh yeah, the RSI is at its highest level of the year.  The obvious stop is a percent and a half away; even if you're bullish, it would seem churlish not to book some profits here.

In the intermediate term, they may sink or swim based on an old-fashioned notion of central bank credibility; namely, whether the Fed can successfully extricate itself from the corner that it's been painted into.
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washedup
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November 3, 2015 at 1:28 PM ×

good post MM - little bit like the compulsory humanities paper that the precocious pre-med student has to turn in - credibility is a tough subject - just hope I am smart enough to spot it when the rank and file start disbelieving the fed - I think most hedge funds already carry around naked pictures of them anyway, right next to their job applications.

You would think their credibility would be strained the most if the productivity 'slowdown' we have been seeing for the last 5 years gains in force - it will be basically impossible for these guys to deal with compressing and stagnant margins in corporate america along with wage inflation and muted consumer spending. Its a problem they have dealt with exactly zero times.

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Anonymous
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November 3, 2015 at 2:34 PM ×

I start every trading viewing this chart and keep on saying this can't go on, this can't go on...

http://imgur.com/9OyUhdU

Makes me a more cautious trader though.

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abee crombie
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November 3, 2015 at 3:06 PM ×

i think BOE knew what they were getting with Carney. He did the same 'waffling' with BoC. Anyways i dont have a problem paying CB's competitive market salaries and also opening up the positions to non PhDs. I'm sure he would be making more if he had stayed with GS...

If you consider of much we are willing to pay CEO's CFO's etc, why not pay the most important person in the country's economy a similar wage. Although we all know that independent CB's are really not, and politics still plays a big role... but then I guess the conflicts of interest might be even worse....

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Unknown
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November 3, 2015 at 3:36 PM ×

If Carney wants to get as much as he can, fine, but then he loses all moral authority to criticize others' pay. Moreover, if he sees nothing wrong with hiring a guy from Brevan to the MPC and letting him keep his interest in BH, he is either stupid, naive, or corrupt. I'm not sure which is worse.

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Unknown
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November 3, 2015 at 3:37 PM ×

That last comment is from MM

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Anonymous
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November 3, 2015 at 4:12 PM ×

As for central bankers being either: stupid, naive, or corrupt - it's worse, they are all of those and more.

I very much hope this ponzi continues for the simple reason that when it crashes the fallout will be so bad, that I sincerely believe central bankers will be executed or at the very least face life imprisonment. I'm not being silly here, I honestly believe we will have massive social upheaval in the West in the next 10 years, and possibly civil wars. Central bankers will be the politicians' scapegoat - you can already see many politicians distancing/blaming them.

It sounds harsh, but when you consider these guys have basically destroyed society and free markets, the punishment fits the crime.

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Anonymous
admin
November 3, 2015 at 4:35 PM ×

" I'm not being silly here"
Of course you are, but it's silly that you recognise it.

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Anonymous
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November 3, 2015 at 5:34 PM ×

The problem with all this is that IF the BIG Macro names are getting all this information, then why are their last 5 years' numbers comparable to that available from a bank deposit? - And in some high profile cases shockingly worse. [Taking the other side - I guess they might be losing 5% a year instead of making 3 % without all the 'help']

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Macro Man
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November 3, 2015 at 5:56 PM ×

One answer is that the linkage between modern central bank policy and traditional macro playthings- notably short rates- is much more tenuous in the past. Another is that there clearly has been some sort of impropriety in the past- one well known fund made money like clockwork when Trichet was in charge of the ECB, and has generally struggled since.

The over-arching point, though, is that when certain private sector actors are being flushed down the toilet by regulatory pressure despite doing nothing wrong- and I know several who fit that category- the CBs really need to avoid even the faintest whiff of impropriety, which they are studiously not doing.

Put another way- if the regulatory standard for the pvt sector is now guilty until proven innocent, well the same standard should apply to the public sector as well. Otherwise the result is inevitably tyranny.

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CV
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November 3, 2015 at 6:19 PM ×

"Put another way- if the regulatory standard for the pvt sector is now guilty until proven innocent, well the same standard should apply to the public sector as well. Otherwise the result is inevitably tyranny."

Well yes, I fear you are more right on this one than you know MM! I don't believe in the Mad Max scenarios expounded above, but CBs have a monumental problem on their hands. In the EZ and Japan at least, they are fighting a losing battle. They will never reach their "inflation targets", and my feeling is that the big shock will be when someone takes the helm who understands this.

Right now, the printing press/ZIRP is being primed, leading to a perennial state of Goldilocks. What if the ECB realised that trend nominal GDP growth is closer to 1-to-1.2% and therefore inflation should also be 1-to-1.2%?

It won't happen tomorrow, but eventually I suspect it will.

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DownWithTheBeanCounters
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November 3, 2015 at 7:07 PM ×

Most of the commentary I read suggests that Fed credibility is diminished every time the board passes on the opportunity to raise rates. As was alluded to in the post The Fed's credibility also rest on the board's ability to keep people employed and prices stable. In that sense, a central banks credibility depends on the extent to which their actions are "correct". So... Ben Bernanke and Janet Yellen are some of the most credible central bankers in history.

There is significant frustration with the rate-raise delay and calls for central bankers to give up and admit that they will never achieve their inflation goals. How does that differ from what the Fed has been doing vis a vis UE and the first rate hike? Why is "bowing to reality and lowering the inflation target" more credible than acknowledging that there is more slack than thought in the labor market (because wages and prices are responding as expected) and lowering the NRU?

Is inflation everywhere and always a monetary phenomenon?

Is this formula a silly toy: MV = PQ?

Will the Ben Bernanke pajamas I so obviously desire be under my Christmas tree?


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abee crombie
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November 3, 2015 at 7:30 PM ×

Thank MM, I didnt realize the ties were so deep, I thought that was reserved for EM.

i have the solution. Bitcoin! no seriously its pretty awesome how the whole system developed, the only problem is that it makes too much sense and that it cant be manipulated

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Mr. T
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November 3, 2015 at 7:31 PM ×

I would consider a lot of the scandals here as important, but not really altering credibility. To me the credibility issue stems from the moving of the goalposts and general breakdown of communication. Credibility is all about do people believe you. When the fed said they would raise rates when U6 got below 6.5%, people believed them. Everyone knows and has always known that U6 is an imperfect measure, it was assumed that the fed was incorporating the U6 error bars into their assessments. If Yellen now says "we will raise rates when CPI gets to 2% for 3 months", does anyone really believe them? CPI too is an imperfect measure. This gets to the root of the issue where credibility is lost and in the process fed policy looks more and more reactionary than anything else. The fed has backed away from explicit guidance, possibly acknowledging that it erodes their credibility and gets them in trouble. Fine, but damage has been done.

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Macro Man
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November 3, 2015 at 8:03 PM ×

Actually, the problem with bitcoin is the limited supply has created a predefined of rentiers who would be due a fabulous unearned windfall if BTC were ever to become a widely used currency. There are currently 15m bitcoins in existence; the maximum possible is 21 million. The math doesn't work without creating massive income inequality...which, of course, is the goal of most BTC proponents and holders!

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DownWithTheBeanCounters
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November 3, 2015 at 8:44 PM ×

Mr T-

I don't think the goal posts have been moved. The goal posts are set at employment to a level commensurate with price stability. The problem is that we are facing a particularly unusual set of economic circumstances and ambiguous data.

It's not so much that the Fed has moved away from explicit guidance as that they have moved toward data dependence. Even though I have spent a career exploiting fallible models I still prefer this stance to policy set by the capricious intuition of some maestro.

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Anonymous
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November 3, 2015 at 9:02 PM ×

MM - some v good replies, above, thx.

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abee crombie
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November 3, 2015 at 9:40 PM ×

Regarding bitcoin, yes the amount in circulation is limited and will grow only slowly after 2020 but that is just an artifact of this initial design. There could easily be a new crypto currency that leap frogs Bitcoin.

We could easily issue a "new" bit coin, that steadily grows supply 1 or 2% pa forever.

The massive income inequality caused by 21M bitcoins is no different than that under a gold standard. And judging by the job QE has done, I'm not sure fiat money is much better. In any monetary system it seems some will benefit more than others, but at least with bitcoin you know the rules. The actual amount isnt a big deal. It wouldnt matter if its 21M or 100Billion. They are easily divisible

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Anonymous
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November 3, 2015 at 10:22 PM ×

Sorkin: "Are you anticipating chaos?"

Druckenmiller: "Yes..operating under the assumption..primary bear market started July"

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Anonymous
admin
November 3, 2015 at 11:10 PM ×

@abee - bitcoin will never be allowed to become a significant challenge to fiat. Modern governments need fiat so that they can engineer inflation and thus manage debt burdens. Debt burdens are the byproduct of buying votes & distorting the financial system. Buying votes allows for power & corruption. Simples.

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Anonymous
admin
November 3, 2015 at 11:38 PM ×

@Anon 10:22 - Thank you for the heads-up on the Druckenmiller conference.

To all, PLEASE check it out, well worth the time:
http://www.valuewalk.com/2015/11/stan-druckenmiller-dealbook/

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Anonymous
admin
November 3, 2015 at 11:52 PM ×

Crude Oil Final Test Before Full Blown Bull is 50.88

http://www.dailyfx.com/forex/technical/elliott_wave/oil/2015/11/03/eliottWaves_oil_2.html

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Anonymous
admin
November 3, 2015 at 11:58 PM ×

http://blog.kimblechartingsolutions.com/wp-content/uploads/2015/11/crudeoilbullishfallingwedgenov31.jpg

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