Wheeler asks the questions: will Yellen answer?

If the Fed's Jackson Hole conference is the main course of the monetary policy week, RBNZ governor Graham Wheeler cooked up a tasty appetizer yesterday with his speech on "Monetary Policy Challenges in Turbulent Times."  The speech offers a useful summary of the state of play of modern central banking, and while the decline in the neutral rate of interest is acknowledged and addressed, the fetishization of R* that has characterized the US policy discussion is notably absent.

Instead, Wheeler draws several important points, acknowledging the limits of policy efficacy more explicitly than many of his peers:

* "Expectations of what monetary policy can achieve often run ahead of reality"

*  "Low inflation in some countries is linked to demographic change, especially in countries with a declining workforce and rapidly ageing population. Low inflation is also due to technological change around information flows and energy production, and to the global over-supply of commodities and manufactured goods"

* "Central banks only have limited control over tradables inflation. For example, they have no influence on the global oversupply of commodities, manufactured goods and capital goods, or on overseas inflation rates"

*  "The decline in neutral real interest rates may be linked to the slowdown in productivity growth, and the growth in global savings linked to post-GFC deleveraging and aging populations"

*  "In responding to this economic setting, monetary policies are being stretched well beyond the normal parameters and stresses envisaged when policy frameworks were designed and inflation goals were first specified" 

He also raises a number of key questions that policymakers are confronting, which perhaps offers a guidepost to the sorts of topics that Yellen might cover on Friday:
  
* what are the risks that global growth will be revised lower? What is the outlook for commodity prices, and especially oil prices? How can the advanced economies achieve the growth rate needed to generate the ‘escape velocity’ to ensure a durable recovery and moderate inflationary pressure?; 

*  how long are the major central banks likely to run a divergent monetary policy stance (although they have become more similar as the Federal Reserve has pushed back expectations of interest rate rises)? When might the Federal Reserve next raise the Fed Funds rate?; 

* has monetary policy reached the limits of its effectiveness in central banks with negative policy rates and large programmes of quantitative easing? How much scope is there for additional monetary accommodation and will this be deployed - especially by large central banks, such as the European Central Bank and Bank of Japan?; 

* how serious are the distortions created by negative interest rates, and by quantitative easing and the associated rapid expansion of central bank balance sheets? How can these balance sheets be deleveraged over time and excess bank reserves absorbed, and what does this imply for monetary policy, asset prices and global long term interest rates?; 

* what are the risks that inflation expectations will fall further? How can inflation expectations best be raised when policy rates are already low, household indebtedness is high and households and firms are reluctant to borrow more?; 

* how reliable are the central bank’s estimates of the output gap? How flat has the Phillips Curve become and how much has the neutral interest rate fallen?; and 

* how should fiscal policy support monetary policy?

In the meantime, we are left with remarkable flat money market curves throughout the world, including the US.  EDZ6/EDZ8 currently trades at just 27 bps; while there is of course the impact of the money fund-related boost to LIBOR impacting the front leg, that's still remarkably flat (and perhaps worth a flutter?)


Even more notable is the flattening further out the curve.   The 5th vs 13th contract spread is just 25 bps, the lowest it's been since before the crisis (when Fed funds were 5.25%, not just north of zero.)


Contrary to the belief in some quarters, central banks are not omnipotent, as Wheeler suggests.  The sooner that certain members of that fraternity embrace that fact, in all probability the better off we will all be.
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Anonymous
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August 23, 2016 at 1:01 PM ×

Nice post, and I agree with your sentiment, but it's immaterial. We know monetary policy doesn't work (just examine Abenomics), however politicians will do nothing, and Central Banks are "all in" so will just do more NIRP/QE forever. Thus the problem will get worse until, finally the entire debt burden is monetized, and the system is reset. There is no way out.

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Anonymous
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August 23, 2016 at 1:08 PM ×

But..but..they told me that they have helicopters and lots more cool stuffs in their magic hat.

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checkmate
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August 23, 2016 at 1:12 PM ×

"There is no way out."
I disagree. The 'way out' remains fiscal policy and in true zen like fashion if you wait long enough for the pendulum to swing then it will indeed swing. The tone of economic discourse is changing and I suspect an internet search on hits for fiscal policy might highlight that statement. The way I look at this is the central banks never ever resolve anything per se. They just buy time for politicans to switch the dialogue around. In this case that means from preaching austerity to recognition that when austerity equals a decrease in public spending then monetary policy is having to cartry twice the load . The UK will take the lead on this sooner than later if only because it's just been handed a ready made excuse to do so. When it works watch out for others to climb onboard.

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checkmate
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August 23, 2016 at 1:18 PM ×

FWIIW the above for me meant switching out of overextended govt bonds and other 'nil' value bonds across to select Retail and Engineeering/ Civil construction equities.
If that plays out well then I would imagine that by the time the Autumn budget statement comes out in November we might have got the bulk of the front running out of the way.

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Anonymous
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August 23, 2016 at 1:49 PM ×

Checkmate said, "The 'way out' remains fiscal policy." Fiscal policy is indeed the New Extraordinary policy, but it is not working against demographic challenges in Japan any better than monetary policy is. Nor has it worked to prevent China's slowdown. Meanwhile, here in the US, the last time we tried fiscal policy in 2009, it was hijacked by a partisan Congress and was a complete disaster, costing the Democrats their House majority. It might catch on at the Fed, but good luck convincing any Congressmen to vote for it.

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Anonymous
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August 23, 2016 at 1:59 PM ×

https://www.theguardian.com/business/2014/jun/07/inside-murky-world-high-frequency-trading

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Leftback
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August 23, 2016 at 2:39 PM ×

Some incredibly good stuff there from Wheels, especially this:.

"Low inflation in some countries is linked to demographic change, especially in countries with a declining workforce and rapidly ageing population. Low inflation is also due to technological change around information flows and energy production, and to the global over-supply of commodities and manufactured goods"

"Central banks only have limited control over tradables inflation. For example, they have no influence on the global oversupply of commodities, manufactured goods and capital goods, or on overseas inflation rates"

It really is great to have someone articulate in that position who is able to state the obvious so clearly.

On another note...

We knew that vol selling had become insanely popular among 12yo and his friends ("because, like, Yellen, dude. So, like, you can never lose money") but now we hear that state pension funds have joined the throng??? This is really frightening stuff, especially when you think of the mollusk-like macroeconomic IQ levels of the individuals involved.

http://www.wsj.com/articles/pensions-play-with-puts-for-protection-1471777202

This really needs to be nipped in the bud. What could go wrong? How do you even model the VaR involved? These trades really are binary. You either pick up another penny every day or you get obliterated by a steamroller.

Even Dame Janet must realize this is nuts. Imagine what would have (and probably did) happened to punters who were short vol ahead of the 1987 Crash? Even a 10% dump over two days and gosh darn it, some investment committees done got a lot of 'splainin to do.

Btw, where did the oil bulls go? We called the post-expiration turn lower, almost to the minute :-) [OK, we exaggerate.]

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Polemic
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August 23, 2016 at 3:03 PM ×

Agree with MM and LB's last comment.

I'm worried about the complacency of just having savings. Having savings isn't the differentiator. It's having more savings than others.

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CV
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August 23, 2016 at 3:38 PM ×

"This really needs to be nipped in the bud."

You said it. I read that WSJ article, thought it was joke, remembered the world we lived in and just shrugged. Crazy times!

It is getting silly! It can push higher of course, but we all know what happens when the air is as thin as is currently the case. Re the flatteners point. I suppose this is just the lower terminal rate that is playing in here. After all, if the ECB and the BOJ never move, and their liquidity pumps continue to send money into the U.S. bond market ... well, where does that get you then?

The bottom line at the moment, though, is. Everything is going up together ... these periods rarely last for long.

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Armchair expert
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August 23, 2016 at 4:52 PM ×

@LB: Remember what selling CDS's did to AIG in 2008? :)

I'm confident though. I'm happy that when a wall of energy debt needs to be rolled over in 2017, the markets will be sanguine, and all will be well. I'm additionally confident that the lowest volatility in the S&P in 20 years, with VIX falling off the bottom of its chart heralds only positive news for the future of our stock markets.

I'm particularly optimistic that when the Fed, BOJ and ECB have to unwind their asset purchases, FI and Equity markets will rejoice at the opportunity to buy these assets at bargain prices, thus setting off new bull markets everywhere.

Finally I look forward to seeing the lowest ST interest rates in 300 years mean revert to 4.5%, and mortgage rates revert back to 10-15% pa, just as the boomer generation downsize their 4-5 bedroom homes into a market where millennials cannot afford starter homes. I'm confident that our re-capped banking sector can absorb these shocks, and all will be well.

The future looks bright.

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Mr. T
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August 23, 2016 at 5:01 PM ×

Btw, where did the oil bulls go? - Ones here, with natty & lots of other commodities (ex PM's) I think lining up.

For example, they have no influence on the global oversupply of commodities, manufactured goods and capital goods...
I disagree with this. They may have no direct control, but they certainly have influence. As I think has been articulated here at least once or twice, the mechanism of business owners (sharesholders) demanding a higher portion of cashflow to generate yield is most certainly a reaction to low rates, which CB's do have direct control over. In industries where the tradeoff is between payouts and capex, capex %'s are declining, where its only a matter of time until production rates decline or at least fail to keep up with even the modest global growth demands. Hard to see that not resolving itself with higher prices.

The widely held view that lower interest rates, by lowering hurdle rates, was supposed to create capex generation misses the fact that there are competing claims on corporate cashflows.

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Anonymous
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August 23, 2016 at 5:25 PM ×

Yes, remember oil supply investments are long term. Cutting capex today you won't see any effect but you'll see it 5 years afterward as old supply declines, and you were supposed to then get replacement but umm... what about the capex that never was 5 years ago? Is there a single major that hasn't announced huge capex cuts running in the $10s billions? And these scales can be even in a single year.

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Anonymous
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August 23, 2016 at 7:24 PM ×

@LB if you or a/one else is keen on the demographics theme read econimica.blogspot . He explodes it really well

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Anonymous
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August 23, 2016 at 7:25 PM ×

Explodes - explores

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MrBeach
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August 23, 2016 at 7:43 PM ×

At this point, I look at ZIRP/NIRP & QE as the economic (and moral) equivalent of gross environmental pollution at a planetary scale. There is no reversion to 4.5% savings accounts. It can't happen anymore [cost of servicing debt, rising dollar, etc]. There is no reversion to markets pricing risk correctly with a perpetual CB thumb (or forearm) on the scale.

Just like with our runaway climate change (google 'lighting siberian methane bubbles') where a bleak future awaits us, I see no possible escape from ZIRP/NIRP & QE. Sure we'll get some brief periods of semi-stability (similar to the difference between weather and climate) where things will kind of look normal, but the underlying issues will only get worse. Why?

As with pollution, the problem is political. You cannot get elected anywhere telling people to reduce their carbon footprint and take the economic/lifestyle hit in the process. Similarly, you cannot get elected anywhere telling people that they must accept the consequences of their economic choices [see TARP, bailout of AIG, QE].

So we steam onwards towards environmental and economic turbulence.

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Leftback
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August 23, 2016 at 7:57 PM ×

Discount rate minutes show 8 regional banks supported a hike in the discount rate:

https://www.federalreserve.gov/newsevents/press/monetary/monetary20160823a1.pdf

We are not founder members of the Hawks and Hikers Club (as regular readers will be aware) but we think the writing is on the wall after the recent Dudley and Fischer commentary. Students of Fedspeak may be wary but one would be advised to pay attention to this.

Bravo, @Mr Beach, btw, we agree wholeheartedly with your assessment.

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Polemic
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August 23, 2016 at 9:00 PM ×

Hand up to being another oil bull.
And a EURGBP bear. the world of five min Macro is short with large possies registering on short side but the corporate world is buying as exports boom and the Brexit surprise indicator of recent data is high. Well surprise toa lot of economists who seem to believe that they lead behaviour rather than follow it. First the pesky public refuse to go woe is me and carry on spending and then naughty industry won't listen and is nowhere near as gloomy as the economists told them to be.

There are a lot of exceedingly arrogant economists out there who, like reporters, appear to think it is their mission to change beliefs rather than reporting or predicting them.

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Polemic
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August 23, 2016 at 9:01 PM ×

Short of GBP, not eurgbp, that was

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Anonymous
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August 23, 2016 at 9:13 PM ×

I wish I was a middle-eastern oil producing nation... I would mention excess supply and watch CL fall 8-10%, then buy every CL contract in existence, shortly after I would release a rumor that supply was diminishing. Once CL rallied 8-10% I would sell it all, and deny the rumor.

The following week I would repeat it again, ad infinitum. I would then blame the USA for all my nations woes.

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Leftback
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August 23, 2016 at 9:32 PM ×

Yes, crude oil has always been one of the most cynically and frequently manipulated markets and the recent action is no exception, someone big got caught long and then had to engineer a 2 week squeeze so they could get out closer to $50/bbl. Now watch as the news stories of "NIgerian incidents", "Iranian embargoes", "Canadian wildfires" and "OPEC production cuts" just disappear as the oil price resumes its inexorable drip drip drip lower.

LB is at some point going to be an oil and energy company bull, but not until we see a real period of Price Discovery, and a consequent wave of minor bankruptcies, fire sales and mergers. There is a price for SDRL, RIG, CHK etc.. but it's not where they are currently trading, and for some of them (because of debt) it may be that they trade down to $0. We still own shares in TOT, BP, OMV, E, Gazprom, Lukoil, Repsol and the like. It's good to own a piece of the real economy, but we will not be adding until we see the fire sale prices return (and maybe dividends are reduced by the majors), perhaps as soon as this winter. A lot of punters have forgotten what can happen when the USD puts in a surge against an insipid economic backdrop. It may get nasty.

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washedup
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August 23, 2016 at 9:42 PM ×

@anon 9:13 - and whats the likelihood that an oil producing nation that would have to rely on goldman, Morgan, and JP Morgan to execute its 40-50k lots sales would be able to keep this 'strategy' under wraps for more than 5 seconds?

@Left your conviction on the fed action is interesting, and I must say quite contrarion - the problem is the game theory aspect of this - these clowns have zero balls in terms of wanting to surprise the (cough equities) markets, which tells me that yellen's speech on friday pretty much would need to serve as a de facto announcement of sorts - for her to be able to thread the needle between a gentle hint to prepare the patient without sending it into a schizophrenic rage seems difficult - said differently, the 'you were warned' idea only works if we assume these guys can actually take the consequences of a market surprise - lets just say I am not holding my breath, so count me in with the masses!

JPY really does look like its at a do or die level I have to say - the divergence between JPY and risky assets is greater than I have seen in about two decades, and I have no idea which one is right.

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Nico G
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August 23, 2016 at 11:25 PM ×

more on my darling bank

http://www.newyorker.com/magazine/2016/08/29/deutsche-banks-10-billion-scandal?utm_source=pocket&utm_medium=email&utm_campaign=pockethits

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Anonymous
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August 23, 2016 at 11:47 PM ×

Just wondering what the big picture is right now: are equity indices really related to anything else anymore other than how much CBs can or can not further compress yields? Not trying to make predictions but just questioning (if that's the case) if the juice on that, and generally the long term bull market is running out, like the spring is really getting really loaded now and can't hold it down forever. Are equities really much else than picking up pennies before the steamroller looking at 2008-2016 context and considering past bull market lengths? Albeit of course there is the case that this one is unprecedented and different because CB omnipotency and even the below average growth achieved has been achieved through unprecedentedly high debt growth so this could basically go on "forever"?

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Leftback
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August 24, 2016 at 12:18 AM ×

With realized volatility currently at 20 year lows, the probability is rising that "this" will not go on "forever".

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Anonymous
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August 24, 2016 at 5:20 AM ×

@LB: after a summer of working my way out of several long VIX forays with only a few minor bruises, I'd say it will go on longer than many of us are willing/able to keep rolling forward. It's wonderfully obvious that volatility will come roaring back some day, but cheaper to buy lottery tickets.

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funloanfirm
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