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May 31, 2006
Funds Rate Predictions: Special Minutes Release Party Edition
Ok, I did say I would continue to post these pictures when something interesting happened. This would be one of those times. The market has spoken, and the market (for options on federal funds futures) says the probability of another 25 basis point increase seems a lot more likely now that the world knows what the FOMC was thinking at its last meeting. The short story:
This data -- and more -- will be available tomorrow, via the Cleveland Fed website.
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Did Somebody Actually Say 50 Basis Points?
The FOMC has spoken -- or at least indicated what the members had spoken among themselves at their May 10 meeting -- and the general feeling among the usual collection of expert commentators is that, as far as more rate hikes are concerned, all signals are still go. A representative comment, from the Wall Street Journal ...
The general tone of the commentary is consistent with policy tightening not being done at 5.00%. One statement that jumps out is in the section of the minutes that discusses the actual policy move: "Still, it seemed most likely that, with modest further policy action, including a 25 basis point firming today, growth in activity would moderate gradually over coming quarters, pressures on resources would remain limited, and core inflation would stay close to levels experienced over the past year." In other words, on May 10, most FOMC members were anticipating that they were not finished tightening policy with that day's [quarter-percentage-point] hike to 5.00%.
-- Joshua Shapiro, MFR Inc.
... seconded at BusinessWeek Online:
It seems the inflation "hawks gained the ascendancy at this meeting," said Dominic Konstam, head of interest rate strategy at Credit Suisse in New York. "The Fed is more cognizant of the need establish credibility over inflation,"he added.
Here's the passage in the minutes that seemed to really get people's attention:
Although the Committee discussed policy approaches ranging from leaving the stance of policy unchanged at this meeting to increasing the federal funds rate 50 basis points, all members believed that an additional 25 basis point firming of policy was appropriate today to keep inflation from rising and promote sustainable economic expansion.
Emphasis added there, and by many others. Once more from BusinessWeek...
Ian Lyngen, interest rate strategist at RBS Greewich in New York, said the comments on inflation, the discussion of a possible 0.50 percent rate hike and the fact that the Fed wasn't yet seeing evidence of a slowdown in growth gave the markets a "hawkish" tone.
... from Bloomberg...
"People were thinking they were either going to pause or go 25 basis points,'' said Ethan Harris, chief U.S. economist at Lehman Brothers Holdings Inc. in New York. "The fact that they are even talking about a half-point rise sounds a little more hawkish, I think, than people had expected.''
... and from the WSJ:
... The fact that a [half percentage] point hike in May was even discussed beggars belief, and it suggests now that we need to see a clear softening in the data if there is to be no hike in June.--Ian Shepherdson, High Frequency Economics...
That reference to data-dependence is still the theme of the day, but the consensus seems to be that the economic news since the meeting has been tipping the scales toward another move in June. Again from the Wall Street Journal...
... In this environment, the hawkish tone of the May FOMC minutes reinforces our lean that the Fed will tighten again at the end of June unless the May CPI figures give them a compelling reason not to.
--Stephen Stanley, RBS Greenwich Capital..
and from Reuters...
"The market is taking a bearish tone on the Fed's policy outlook," said Gary Schlossberg, senior economist at Wells Capital Management in San Francisco. "Today, it (FOMC minutes) didn't help with the case of a pause."...
"I don't think there is anything in the data flow since May 10 that would lead you to conclude other than that they raise rates at the end of June," said Joseph Balestrino, fixed-income strategist at Federated Investors in Pittsburgh.
"If the hawks were concerned on May 10 ... then they must be in 'hair on fire' mode now," said Steve Stanley, chief economist at RBS Greenwich Capital.
[Drew Matus, senior economist at Lehman Brothers] said the minutes do suggest that the Fed was looking at a way to pause in June when the central bankers met on May 10.
"I thought this came across as emphasizing the pause," said Matus. "Most of the commentary about concerns about inflation was balanced by commentary about growth. But since the time of the minutes, the game has changed and the inflation outlook is worse than when they were writing these minutes."
Not everyone thinks the story is over just yet. From the NY Times article...
... David Wyss, chief economist with Standard & Poor's, said he's still expecting the Fed to hold off in June, although he now thinks it's a bit more likely there will be one more rate hike at a subsequent meeting.
"The thing that strikes you number one [about the minutes] is they are worried about inflation," said Wyss. "At the same time they are talking about the expected cooling of the economy. I think it's going to be a race between how quickly inflation heats up and how quickly the economy cools off."
... and from the WSJ article:
The tone of the minutes was consistent with our view that the majority of officials may prefer a pause at 5%, but are unsure whether the incoming data will allow them to do so...--David Greenlaw, Morgan Stanley Fixed Income Economics
Looking for certainty from the Federal Reserve these days is like waiting for Godot. You can talk and talk and talk about it, but it never comes.
Well geez, if the world would just cooperate...
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May 30, 2006
Where Are My Federal Funds Rate Predictions?
The bad news is that probabilities for the path of the federal funds rate estimated from options on federal funds rate futures will no longer be a regular feature of macroblog. The really good news is that you can now get them everyday from the Cleveland Fed. Here's what you can find, and where you find it:
-- Pictures of the probabilities estimated for the most recent trading day, with links to the data in both Powerpoint and Excel spreadsheet format.
-- A handy FAQ page.
-- Background publications describing the market for options on federal funds rate, and the methodology used to obtain the estimated probabilities. (This section will also contain any future research papers related to the topic.)
From this day on, there will also be an archive of all published files. In the works: A simple user-friendly program that will allow you to estimate probabilities based on your own specifications.
Although I will continue to highlight the estimates when they seem particularly interesting, I will no longer automatically feature them every week. I know a lot of you checked in for that information specifically, and hope you keep coming back nonetheless. I'll try to say something worthwhile every now and then.
Thanks to all of you who have supported my efforts to make these estimates available through this weblog. And many, many thanks to John Carlson, Ben Craig, Will Melick, Monica Crabtree-Reusser, Erkin Sahinoz, and Pat Higgins who have ushered the Cleveland Fed site to reality.
UPDATE: Oops. I inadvertently omitted the name of Saeed Zaman from the list of those integral to bringing the fed funds futures site to fruition.
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May 29, 2006
Why I'm Not Convinced The Yuan Is Undervalued
From the May 30 edition of the Wall Street Journal
(on the opinion page in the print version):
Though it's hard to believe, China's sickly mainland bourses are the best-performing in Asia this year to date...
In normal economies, stock prices are based on expectations of a company's future earnings. China, however, isn't a normal market. Sure, mainland company profits are up slightly. But Chinese corporate profit forecasts -- when they're available -- are often linked closely to expectations of how the government will regulate a sector or company. Not to mention the poor corporate governance, lax financial disclosure and haphazard regulatory environment that lace the mainland's markets...
Foreigners aren't behind the recent euphoria. China's qualified foreign institutional investor program, which lets the waiguoren punt alongside the locals, is worth only about $6 billion. That's doesn't count for much in a market of around $450 billion. And not all of that foreign money is invested in stocks, either.
That leaves China's famed domestic punters, who may feel emboldened by other Asian stock market gains over the past few years. Or perhaps, given their limited investment options, China's investors simply can't think of anywhere better to park their cash...
The interesting question is, where would that domestic saving go in the absence of the extensive capital controls that support the PBoC's ability to so tightly control the value of the yuan? Anyone want to bet it won't be in China?
Bread Setser raises a related issue in a very interesting post on the Chinese government's attempts to recapitalize its (presumably) ailing banking system with its very nice collection of dollar-denominated assets. Says Brad:
That is the problem with giving the banks the country’s foreign exchange reserves. It creates a currency mismatch on the banks’ balance sheet. Potentially a big one. RMB deposits need to be matched with RMB bonds and RMB loans. Not dollars or Euros. If the banks get dollars or euros, and the dollar or euro depreciates against the RMB, good banks will become bad banks quickly. Depreciating assets are not a good thing for a bank...
There is one set of circumstances where China’s bad banks could require China to use its dollar reserves. It goes like this.
Chinese bank depositors lose confidence in China’s banks, and start to withdraw deposits from the banking system in mass. That would be a big change from the very strong deposit growth we are observing right now. But it could happen...
As depositors pulled their funds out of the banks, they would end up holding a huge stash of RMB cash. And they might want to convert that to dollars or euros.
China has capital controls, so this isn’t easy. But let’s suppose for the sake of argument that the controls are lifted. The central bank maintains a de facto peg – so the depositors could sell their RMB to the central bank for its dollars...
Two key points:
First, the dollars are useful if Chinese citizens want to pull their funds out of China. ..
Second, with a current account surplus of $150b (and growing) and net FDI inflows of $50b, Chinese deposits could send up to $200b a year without requiring the central bank to dip into its existing reserves at all. Rather than financing reserve buildup, China’s enormous surplus in its basic balance of payments would just finance capital flight.
Of course, Brad thinks -- and he is surely right -- that there are a lot of other fairly good candidates to which that capital could eventually fly. But I'd say you'd want to at least imagine that these arguments bound the downside.
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May 27, 2006
PCE Inflation: Not Horrible, Not Good
The trimmed-mean PCE inflation rate for April was an annualized 3.0 percent. According to the BEA, the overall PCE inflation rate for April was 5.9 percent, annualized, while the inflation rate for PCE excluding food and energy was 3.0 percent.
The following table summarizes the Dallas data:
Flat out, the continued upward drift in core measures, anyway you measure them, cannot be welcome. However, the fact that the news was about what people expected seems to have had a calming effect. From MarketWatch:
"The as-expected data should be a mild negative for the U.S. dollar in that it does not make the case that inflation pressures are rising, but rather remain contained," said traders at Gain Capital. "In this sense, the picture is developing very much along the lines of the Fed's forecast, suggesting that a pause is still the preferred scenario."
However, the fact that the year-over-year number is "just over the Fed's comfort zone" is "slightly dollar-positive. But the bond market didn't seem to think so," said Action Economics' Simpson.
The PCE reading "is fairly neutral," he said. "This one piece of data is not going to determine what the Fed does at its next meeting."
Which means, I think, that everyone walked away from the report believing just about what they believed before the report. From the Wall Street Journal:
...We continue to think that the FOMC will see the inflation as a lagging result of earlier strength in economic activity and will probably choose to stand pat. But, of course, there is still a month's worth of data yet to go.
--Goldman Sachs Economic Research...
As long as inflation expectations remain "contained" this acceleration can be written off by the Fed as a temporary pass through of higher energy prices and not necessarily prompt a significant change in strategy.
-- Morgan Stanley Fixed Income Economics...
... I expect the FOMC will pause in June.
--Naroff Economic Advisors Inc.
These data are consistent with our view that the FOMC will pause at its upcoming June 28/29 meeting in order to further assess the economic landscape....
-- Joshua Shapiro, MFR Inc.
And in the other corner:
Core PCE prices are rising at even faster annualized rates of 2.3% and 3.0% over the last six and three months, respectively. These inflation data do not, in our judgment, support the view of a pause at the June FOMC meeting.
--Bear Stearns U.S. Economics...
With a low likelihood of precipitous slowdownand emerging signs that core inflation and inflation expectations may be creeping higher, the Fed will likely hike the federal funds rate again at the end of June...
--Peter Kretzmer, Bank of America...
These data add weight to the argument that GDP growth is still strong enough and inflation is still threatening enough to cause the Fed to raise interest rates further.
--Peter Morici , University of Maryland
Have a nice weekend.
Note: This is a revised version of the original post, which was altered to some formatting problems.
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May 26, 2006
China continues to be one of the most fascinating economic stories going. And going, and going, and going. From today's Wall Street Journal (page C1 of the print edition):
While there has been a stampede out of emerging markets in the past week, China's stock markets have held close to their highest levels in two years. It is the latest evidence that China's investors take their cues from events close to home.
Meanwhile, from China Daily:
China's yuan strengthened to close below the psychologically important eight to the dollar for the first time since last year's revaluation aimed at greater exchange rate flexibility.
In part, the strength might be attributed to the steady ongoing march toward market liberalization. From the Journal article...
This year's surge has been prompted by Beijing's steps to fix problems that have tripped up China's stock markets for the past four years. So far in 2006, the benchmark Shanghai Composite Index is up 37% amid some of the heaviest trading volumes. The rise has been triggered partly by news, made official Thursday, that China will allow initial public offerings of shares for the first time in a year.
... and from Reuters:
In its 2005 report taking stock of the country's financial reforms, the People's Bank of China said liberalization of its exchange rate regime would continue to be a key policy focus.
"We will push forward reform of the foreign exchange management system and perfect the formation mechanism of the yuan's foreign exchange rate," the central bank said.
It also said it would push ahead with efforts to liberalize interest rates and seek to create new financial products, while continuing reform of state-owned commercial banks.
All good, but slow and easy still does it. From the China Daily piece:
"There's definitely a trend for the yuan to rise in value in future," said Sun Lijian, an economist at Shanghai's Fudan University. "But it's not going to be as fast as many believe."
There is only so much change the Chinese economy can absorb and the banking sector in particular needs a stable environment to carry out much-needed reform, he argued Monday.
According to the World Bank, that's a good thing. From Xinhua Online:
A major change in China's yuan exchange rate could have unpredictable effects on the country's booming economy and the Chinese Government's cautious approach to currency reform is understandable as a result, the World Bank's China country director said yesterday.
In a news briefing on the release of the World Bank's five-year development strategy in China, David Dollar said China was still a developing country with a weak financial sector and a lot of weak institutions.
"For the exchange rate, I have a lot of sympathy for the Chinese Government approaching that cautiously," he said. "I agree with the macroeconomists who think that it's in China's interests to allow some appreciation of the currency but I respect the government wanting to make that move gradual."
"A big change in the exchange rate really could have unpredictable effects on economic growth," he said.
In fact, those financial markets remain a bit of mystery. Once more, from the WSJ:
Interpreting market events is tough for China's investors. Personal finance columns in the tightly controlled media are often unsigned views on single stocks, while on-the-air commentators duck the specifics on the big trends by referring instead to historic charts, public opinion polls and financial news from overseas...
Wall Street experts aren't much use in China because few have licenses to dispense retail investment advice. No matter how much stock prices on the Shanghai and Shenzhen exchanges rise, their interest is limited by a cap on foreign investment of only 1% of the $530 billion in Chinese market capitalization. Instead, foreigners focus on Chinese stocks traded in Hong Kong, where different fundamentals prevail...
Until recently, Larry Lang was China's best-known economic gadfly. He appeared on television each Friday night to rail against inequities he saw taking place as China shifted toward a market-based financial system.
His show was canceled just as stocks started to sizzle. Prof. Lang declined to comment, saying by email: "This is not a good time for me to talk about stock markets."
And the beat goes on.
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May 24, 2006
Last week bad inflation news, this week bad growth news. That was my first reaction to this morning's Manufacturer's Shipments, Inventories, and Orders report for April. From Reuters:
New orders for U.S.-made durable goods tumbled an unexpectedly large 4.8 percent in April...
Orders for durable items, those meant to last three years or longer, fell the most since January on big declines in civilian aircraft and computer and electronic products orders.
Even with transportation stripped out, orders for durable goods were down 1.1 percent...
The drop in durable goods orders surprised analysts. A Reuters poll had forecast a 0.5 percent drop in durable goods orders on weaker aircraft buying, but anticipated a 0.5 percent gain excluding transportation...
Non-defense capital goods orders excluding aircraft, viewed as a proxy for business spending, dropped a larger-than-expected 1.7 percent. Economists polled by Reuters had forecast a 0.8 percent decline in this number.
Um, that doesn't sound good. But, wait. A little perspective is in order:
Still, the durable goods data is notoriously volatile and April's overall drop followed an upwardly revised 6.6 percent surge in March.
In a potentially positive sign for future production, unfilled orders for durable goods rose $9.3 billion, or 1.5 percent, to the highest level since the data have been gathered in current form beginning in 1992. Unfilled orders have climbed in 11 of the last 12 months.
Plus, the death of the housing market may be greatly exaggerated:
... but new home sales were surprisingly strong last month, government reports showed on Wednesday...
The housing report showed the U.S. housing market defying predictions of a slowdown in April as new home sales rose 4.9 percent while prices climbed, although the supply of homes for sale hit a record.
Aah, feeling better now. But wait. Calculated Risk has this item: Bangalore: New Home Sales – Headline Is Deceptive, Momentum Is Weak. And the Reuters article has this:
A separate report from the Mortgage Bankers Association showed that U.S. mortgage applications fell last week, driven by a steep decline in home buying loans despite a dip in long-term interest rates.
Shoot. Bottom line: Nothing about today's news made anything about this economy easier to figure out.
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May 23, 2006
OECD To FOMC: Keep On Going
For economies already close to full employment, such as the United States, the possibility of a prolonged imported inflation shock, coupled with an upward drift in inflation expectations, may tilt the balance towards further tightening.
In the U.S. country survey, the advice is a bit more direct:
The stance of monetary policy, currently near neutral, needs to tighten slightly to keep the economy in balance.
The good folks at the OECD are less convinced that the recent hawkish talk from the ECB ought to be followed up with action:
For the euro area, where wages and unit labour costs are increasing slowly, the starting point is one where slack is substantial and thus a source of falling inflation. At the same time, if commodity price pressures persist and as evidence builds up that the recovery is firming, the need for monetary tightening should become clearer. Its actual pace, however, should be conditional on unambiguous signs that economic slack is shrinking, which hard data is not as yet confirming.
There you have it.
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Why Betting Against The Dollar Is Tricky Business
In the craps shoot that is economic forecasting, few games favor the house more than trying to predict exchange rates. Perhaps as a consequence, I was taken by this, from the Wall Street Journal (page A1 in the today's edition):
Stocks in developing countries tumbled yesterday, extending one of their biggest losing streaks in nearly a decade, as growing jitters about the global economic outlook amid rising interest rates prompted investors to abandon riskier markets world-wide...
Driving the sell-off: Expectations that central banks around the world, from the U.S. to Europe and eventually Japan, may be preparing to raise rates more aggressively than previously anticipated. News last week that the U.S. consumer-price index rose faster than expected raised the specter that interest rates will have to climb further to curb inflation. Even the recent retreat in commodity prices has not been enough to blunt inflation fears, and since many developing countries are commodity producers, these declines have weighed on their economic outlooks...
... given the current global economic scenario, "these markets are going to be in for a rough couple of months," said Carlos Asilis, a Miami-based portfolio manager for Vega Plus Capital Partners, which has $2 billion under management.
Here's a reminder of how global economic stress tends to affect the value of the dollar:
Of course, the current circumstances are a long way from the full blown crises in the latter 1990s. And things improved today...
Emerging markets outside Asia began recovering from Monday's selloff, tracking rebounds in commodities and gains in most developed-market equities.
Although Monday's selloff followed two weeks of declines that reduced, if not wiped out, many of the gains so far this year, investors are showing signs of resilience.
"What you've seen over the past week or more has primarily been a case of position reduction as risk appetite has declined," said Stephen Gilmore, a global emerging-markets strategist for Banque AIG, a unit of AIG Financial Products Corp. "It's always very hard to know how long risk reduction will continue. I don't think things [in emerging markets] fundamentally have changed."
... and you might argue that the U.S. is particularly poorly positioned in the current environment. On the other hands, The Skeptical Speculator noted that, at least yesterday, "US stocks were relatively resilient compared to the other stock markets"; in Euroland French business confidence is slipping and German investor sentiment stumbled as Eurozone industrial orders fell; and the Bank of Japan has yet to show any urgency in moving short-term rates away from zero.
All of which may amount to exactly nothing. I, along with many others, fully expect the trend in U.S. current account deficits to reverse -- really, any day now -- and I will be less than shocked to see a depreciation of the dollar along with that adjustment. But to anyone waiting for the greenback slaughter, I have one question: If, heaven forbid, the global economy goes south, who ya gonna call?
ANOTHER UPDATE: Menzie Chinn discusses the impact of dollar depreciation on domestic inflation, at Econbrowser.
YET ANOTHER UPDATE: I finally caught up with Brad Setser's post, making much the same point, but with a lot more numbers to back his case.
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May 21, 2006
Data Dependence Points North
Last week's news brought a mix of I-told-you-sos, cringes. and even some sympathy for Mr. Bernanke and pals. I reported on much of this in my posts on the April CPI release -- here and here -- but the reaction continued on through the week. The I-told-you-sos came from Bizzy Blog (honoring the presumed prescient Don Luskin) and from Barry Ritholtz (who has told us so before), seconded by Mr. Naybob. Cringes can be found at The Capital Spectator, at The Skeptical Speculator, from the other side of the ocean via (a skeptical) David K. Smith, and at Asymmetircal Information, sharing the misery with Jim Hamilton. Also at the Capital Spectator, the sympathy. CS is all alone on that one.
In any event, the market has apparently decided that its time to think twice about the rate-hike pause scenario. Once again, the probabilities of a pause in June versus at least one more rate hike switched places, according to the Carlson-Craig-Melick estimates from options on federal funds futures:
August is still a work in progress, but it is clear that sentiments are leaning hawkish:
The data, if it will do you any good:
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