Try as we might to tune out Fed jawboning, our beloved central bankers insist on making their opinions heard. Federal Reserve Governor Jeremy Stein, who has backed extraordinary monetary policy accommodation, said the Fed should more closely link the scaling back of its $85 billion in monthly bond purchases to economic data such as the jobless rate. While speaking in Frankfurt, Germany, Mr. Stein said:
“My personal preference would be to make future step-downs a completely deterministic function of a labor market indicator, such as the unemployment rate or cumulative payroll growth over some period. For example, one could cut monthly purchases by a set amount for each further 10 basis point decline in the unemployment rate.”
We agree that having observable benchmarks might restore some of the Fed’s credibility, if the Fed was true to its word. The markets would be very unforgiving if the Fed retreated from its position when and if a “threshold” was reached. In fact, the market would prefer a target to a threshold. We believe that firm targets data targets are impractical as it leaves the Fed with little latitude to adjust for unforeseen events and unprecedented phenomena.
Mr. Stein went on to say:
“Nobody, I can assure you, was thinking, ‘Let’s do this because it doesn’t communicate well. The most important thing is to get the policy right and, as a second order thing, let’s try not to surprise.”
This supports our view that the Fed will do what it believes is best for the overall economy, even at the risk of angering market participants. However, the Fed must be mindful of how their comments and decisions are interpreted in the capital markets as the Fed relies on the behavior of market participants for the effectiveness of its extraordinary policy measures. That the yield of the 10-year Treasury note is only about 20 basis points lower than pre-FOMC meeting levels might indicate that market participants are wary of taking the Fed at its word.
Minneapolis Fed President, Narayana Kocherlakota (currently non-voting, but who will vote in 2014) said this morning, in a speech, in Houghton, Michigan, that the Fed “must do whatever it takes” to strengthen a slow to recover jobs market. He said that the must be “willing to use any of its congressionally authorized tools to achieve the goal of higher employment, no matter how unconventional those tools might be.”
Mr. Kocherlakota continued:
“Doing whatever it takes will mean keeping a historically unusual amount of monetary stimulus in place — and possibly providing more stimulus — even as the medium-term inflation outlook temporarily rises above the Fed’s 2 percent goal and asset prices reach “unusually high levels.”
Mr. Kocherlakota’ s comments are reminiscent of former Fed Chairman Paul Volcker’s policy of doing whatever it took to defeat inflation or, more recently, ECB President Mario Draghi’s comments that the ECB would do whatever it takes to keep the EMU functioning.
Fed jawboning such as this might be designed to push long-term interest lower. As we have previously stated, the yield of the benchmark 10-year Treasury note is only down about 20 basis points since last week’s FOMC meeting. A 10-year Treasury note above 2.60% is probably too high for the Fed’s liking. We believe that the Fed would be happier with a 10-year note around 2.00%, whether or not market participants allow that to occur remains to be seen.
This is the latest in a long line of dovish comments uttered by Mr. Kocherlakota. We seem to remember that he was somewhat more hawkish earlier on in his career at the Fed. In 2011, he voted against the statement promising to keep the short-term interest rate near zero for two more years.
Up ahead in the Distance
Our outlook is: The Fed will keep monetary policy extraordinarily accommodative for at least another year. The level of extraordinary policy accommodation will be adjusted, up or down, based on economic data. The data which will be looked at most closely are job growth (not just the headline numbers), inflation and GDP growth. It is our view that, barring an unforeseen change to the course of fiscal policy or the rise of a sector or sectors within the economy which encourages full-time hiring, The Fed will continue long-term asset purchases though most if not all of 2014. The Fed Funds rate is likely to remain unchanged until 2016. All forecasts are data dependent, but at the present time we cannot see from where robust job growth and economic growth will come.
By Thomas Byrne – Director of Fixed Income – Investment Consultant
Thomas Byrne brings 26 years of financial services experience to Wealth Strategies & Management LLC. He spent the last 23 years as Director of Taxable Fixed Income for Citigroup, Inc. and predecessor firms in New York, NY. During the course of his long fixed income career, Mr. Byrne was responsible for trading preferred stock, corporate bonds, mortgage backed securities, government debt, international debt and convertible bonds. Mr. Byrne was also responsible for marketing, sales, strategy and market commentary within the taxable fixed income markets.
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