Talk Back

These are the views of Thomas Lam, group chief economist at OSK Group/DMG & Partners:

Notwithstanding the bounce in November consumer confidence on Tuesday, the tightening in broad financial market conditions has been continuing of late. The latter is mainly related to the ongoing sovereign risk irresolution in the euro zone and the growing probability of tail risks associated with significant financial and banking system exposures to the 17-member group.

The financial imprint combined with greater risks of U.S. fiscal tightening at the outset of 2012 should ensure that the downside risks to growth in subsequent quarters persist.

A simple regression exercise that takes into account broad financial market conditions and basic “adverse feedback loop” assumptions shows that if market conditions remain tight or tighten further in the current environment, real GDP growth could potentially downshift and slip into negative territory as early as summer 2012.

(An adverse feedback loop is defined as a situation whereby initial financial market strains weigh on the macro economy, and a weaker economy raises further uncertainty about the financial backdrop, which results in additional financial tightening, greater deterioration in growth, and so on.)

Our proprietary Financial Market Conditions Index, or FMCI, which exemplifies broad financial market conditions in the foregoing exercise, reached a peak around the second quarter of this year and trended lower in recent months. A negative smoothed growth rate of the FMCI is usually an indication of tight market conditions broadly. The FMCI dipped into negative territory in August 2011 and remained in sub-zero territory through November.

Federal Reserve policy makers meet Wednesday to discuss ways to accelerate economic growth. Under consideration are another round of quantitative easing and better communications strategy. However, as discussed below, interest rates would have to be pushed to negative levels–something that is simply not possible–to jump-start the housing market. And the Fed has made clear it intends to keep the federal-funds rate near zero through mid 2013. Likely nothing it says could spur more borrowing for investment or consumer durable purchases now.

Federal Reserve officials are flailing about for new tools to jump-start the economy. Sadly, the Fed has few arrows left in its quill, most are crooked, and Fed Chairman Ben Bernanke appears to not know where the target is.

The legend on Wall Street is the economy remains dormant because depressed housing values prevent homeowners from refinancing their mortgages to free up disposable income and boost consumer spending. Continue reading…

This is a column by James Moore and Scott Mather of PIMCO.

In the Fed’s zeal to try to stimulate the market through a retread of the so-called Operation Twist, this nation’s central bankers seem to have stepped into a realm where No Good Deed Goes Unpunished. In addition to the long bond dropping in yield 40 basis points in the wake of the announcement that the central bank will buy long-term Treasurys, broad equity markets have dropped some 6%. Some sectors, notably financials, have fallen even further.

That the patient has responded violently to the medicine of Dr. Bernanke and team reflects the realization that the cure may be worse than the disease. As we near the zero bound for interest rates, the usual rules do not apply–the second order side effects now dominate and cause more harm to the patient than good.

In its attempt to stimulate borrowing by making long-term money cheap, the Fed has harmed large swaths of savers. A look at three groups in particular proves instructive: pension plans, life insurance companies, and households saving both inside and out of 401(k)s. Continue reading…

These are the views of Thomas Lam, group chief economist at OSK Group/DMG & Partners:

Clearly, financial markets thirst for clues from the prepared remarks of Chairman Bernanke and President Obama on Thursday. But the reality of the situation is that policy recommendations from the president and chairman are not likely to sail through without hurdles and bumps.

Given the earlier extension of the September FOMC meeting to two days to allow for more collective discussions, it was apparent that Bernanke was unlikely to litter meaningful hints in his speech roughly two weeks prior to the meeting. Indeed, the latest speech from Bernanke more or less mirrored the gist of the August FOMC minutes and his Jackson Hole remarks about two weeks ago. The most likely outcome is for the FOMC to embark on some type of asset maturity extension, perhaps by raising and flexibly targeting the average maturity of the Treasury portfolio, together with additional guidance on the future level of overall security holdings (while maintaining the size of the balance sheet) at the September meeting. Continue reading…

(These are the personal views of Peter Morici, a professor at the University of Maryland’s Robert H. Smith School of Business and former chief economist at the U.S. International Trade Commission.)

Federal finances are in shambles, and Americans should be amused if not disgusted by the explanations and solutions both political parties offer.

President Obama’s budget plan issued in February projects a $1.6 trillion deficit for 2011 and a cumulative shortfall of $11 trillion through 2021.

Things may get worse, as additional revenue and cost savings from health care reforms don’t materialize and the 4% growth assumed by the president’s budget for the next four years proves Pollyanna.

Time and again, Obama and House Democratic leader Nancy Pelosi have demagogued the problem, blaming two wars and tax cuts instigated by President Bush and the Great Recession.

Continue reading…

These are the personal views of Lena Komileva, group chief economist overseeing market economic research at Tullett Prebon:

In the end it was the disappointing Federal Reserve Bank of Philadelphia survey and U.S. Dept. of Labor’s jobless claims figures that provided the trigger for a fresh downgrade in investor risk sentiment and appetite for yield in an otherwise peaceful holiday week.

The Philadelphia Fed survey is the most volatile of regional surveys and carries the weakest correlation with the nationwide trend, so the fundamental implications should not be overstated.

Still, the July decline sends an important signal for the health of the economy as it reflects a universal picture of deteriorating corporate sentiment that is driven not by ultra-low Fed funds rates and the strong earnings-driven liquidity reserve accumulated through the past two years’ deleveraging, but by companies’ desire to protect capital and cash-flows in an environment of restrictive credit, local government austerity and future economic uncertainty.

In the survey detail, the Philadelphia Fed purchasing managers’ index manufacturing fell into contraction territory, at -7.7 in August, down from +5.1 in July, for the first time since July 2009 (-8.9). Core growth components sent out universally bearish signals as new business flows, shipments and backlogs all fell and firms slashed inventories and employment.

Continue reading…

These are the personal views of Peter Morici, a professor at the University of Maryland’s Robert H. Smith School of Business and former chief economist at the U.S. International Trade Commission:

Greece is insolvent. No austerity or new taxes will pay its debts.

Like a homeowner owing four times income, belt tightening and a longer repayment period are not enough. Either, the house is sold to clear the debt or the bank takes back the house.

Greek bondholders don’t have that choice–they can’t repossess the Parthenon.

Greece is a sovereign country, and either it will be the recipient of endless German largess–an unlikely scenario–or European creditors, banks among them, will take a loss.

Now, the International Monetary Fund bluntly warns Spain, to avoid becoming the next Greece, that it must radically overhaul labor laws, pensions and consolidate banks–that’s tough for a sovereign that doesn’t print money in the midst of a market panic.

Germany and European banks can’t take that hit.

Continue reading…

These are the personal views of Peter Morici, a professor at the University of Maryland’s Robert H. Smith School of Business and former chief economist at the U.S. International Trade Commission:

Stocks prices have enjoyed a lot of help in recent months.

A moderate recovery–3% gross domestic product growth expected this year and next–and more robust growth in Asia are good for the profits of large U.S. multinationals.

S&P 500 companies earn about half their profits abroad, and the economic recovery is strongest in China, where U.S. companies are well positioned.

Add a great interest rate environment.

The Federal Reserve is holding short rates near zero.

Continue reading…

  By Min Zeng
   A DOW JONES NEWSWIRES COLUMN

NEW YORK (Dow Jones)–Rising Treasury yields are causing some hand-wringing over the market’s ability to absorb the large amounts of debt the U.S. has to sell, but not at high-profile Treasury market bulls such as Goldman Sachs and HSBC.

They and others remain unfazed by the recent rise in bond yields, forecasting instead that weak economic growth and tame inflation will spur demand for low-risk U.S. government debt later this year and force yields back down again.

“The recent move (higher) is a buying opportunity…I don’t think a sustained break above 4.0% in the 10-year Treasury yield will happen,” said Steven Major, global head of fixed-income research at HSBC Holdings Plc in London.

That’s in contrast to the bears’ view–held for example by Morgan Stanley and bond fund giant Pacific Investment Management Co. They argue that mounting U.S. deficits and rising debt supply, seen around $1.4 trillion this year, will push long-dated Treasury yields higher just as the economic recovery picks up speed, driving investors into assets with higher yields than Treasurys.

Continue reading…

These are the personal views of Thomas Lam Tai Loong, group chief economist at OSK Group/DMG & Partners:

There is an ongoing division among economists at this time as to when the Federal Reserve might embark on an interest rate hike.

Although it is impossible to answer this question with certainty at this juncture, it is still important to understand the pertinent arguments that set the stage for the eventual normalization in monetary policy.

Broadly, one camp believes that given the significant degree of slack in the economy, even with positive growth, coupled with low underlying inflation (say, around 1%), the initial removal of monetary accommodation might only occur in 2011. Generally, another group reckons that with continued economic recovery and insofar as underlying inflation stabilizes, there is less need for an emergency policy rate environment in the coming months.

Our prevailing Fed policy forecast–we penciled in the first 25-basis-point hike at the Nov. 3, 2010, meeting–is more in line with the second consideration above.

First, we would contend that the state of market conditions, both financial and credit, is an equally crucial determinant of the timing of Fed policy normalization, at least at the outset. If a general indicator of market conditions remains positive (our Mar. 9 Talk Back “US–Ongoing Market Buzz” discusses one possible market indicator, the proprietary Barometer of Market Stress), this could reinforce the notion that an “exceptionally low” or emergency policy rate backdrop is unwarranted.

Second, we anticipate that even with some removal in monetary stimulus, Fed policy, by and large, should hardly be considered restrictive. Hence, the “less loose” policy backdrop could still be conducive to growth.

Essentially, Fed policy in the current environment operates on two fronts:

1) Interest rates (the interest-on-excess-reserves rate, or IOER, and target fed-funds rate).

2) Reserve quantity (the stock of reserves in the banking system).

Therefore, even when the interest rate channel tightens (say, via an increase in the IOER and target funds rate), the still significant stock of reserves in the system should provide some offsetting effects, ensuring that the degree of policy-normalization proceeds gradually and prudently. (Currently, reserves are in excess of $1 trillion, as compared to less than $100 billion prior to the crisis, but will dwindle in subsequent months. Recently, the Treasury Supplementary Financing Program has begun to absorb some reserves.)

The sequence of a Fed policy exit in the coming months could entail some reduction in reserves (via reverse repos, term deposits and measured redemptions in asset holdings) initially followed by the recalibration of the policy statement.

In our judgment, the former activity of reserve drainage might be closely linked to the movement and durability of the spread between the effective fed-funds rate and the upper end of the target or interest-on-reserves rate of 0.25%. If the spread becomes consistently narrower, within 5 to 10 basis points, for instance, it is probably a good indication that the main policy-normalization tool of IOER could be harnessed more efficiently. Ultimately, to be comfortable with the IOER policy lever, the Fed must be confident with the banks’ willingness to arbitrage and/or the ability to manage other counterparties (like the GSEs) to ensure adequate control of the new policy environment. (The current timeline for testing the term-deposit tool is this spring and the planned arrangement for additional counterparties to participate in reverse repos is by the end of second-quarter 2010.)

In sum, while the Fed is cognizant of “what to do” and “how to do it,” the question of “when to do it” will still be contingent on several factors, namely the state of market conditions, the ongoing economic recovery, the stabilization of underlying inflation and the practical readiness of its policy-normalization toolkit.

(The author can be reached at thomas.lam@dmgaps.com.sg.)