The Atlanta Fed's macroblog provides commentary and analysis on economic topics including monetary policy, macroeconomic developments, inflation, labor economics, and financial issues.

Authors for macroblog are Dave Altig, John Robertson, and other Atlanta Fed economists and researchers.

November 20, 2013

The Shadow Knows (the Fed Funds Rate)

The fed funds rate has been at the zero lower bound (ZLB) since the end of 2008. To provide a further boost to the economy, the Federal Open Market Committee (FOMC) has embarked on unconventional forms of monetary policy (a mix of forward guidance and large-scale asset purchases). This situation has created a bit of an issue for economic forecasters, who use models that attempt to summarize historical patterns and relationships.

The fed funds rate, which usually varies with economic conditions, has now been stuck at near zero for 20 quarters, damping its historical correlation with economic variables like real gross domestic product (GDP), the unemployment rate, and inflation. As a result, forecasts that stem from these models may not be useful or meaningful even after policy has normalized.

A related issue for forecasters of the ZLB period is how to characterize unconventional monetary policy in a meaningful way inside their models. Attempts to summarize current policy have led some forecasters to create a "virtual" fed funds rate, as originally proposed by Chung et al. and incorporated by us in this macroblog post. This approach uses a conversion factor to translate changes in the Fed's balance sheet into fed funds rate equivalents. However, it admits no role for forward guidance, which is one of the primary tools the FOMC is currently using.

So what's a forecaster to do? Thankfully, Jim Hamilton over at Econbrowser has pointed to a potential patch. However, this solution carries with it a nefarious-sounding moniker—the shadow ratewhich calls to mind a treacherous journey deep within the hinterlands of financial economics, fraught with pitfalls and danger.

The shadow rate can be negative at the ZLB; it is estimated using Treasury forward rates out to a 10-year horizon. Fortunately we don't need to take a jaunt into the hinterlands, because the paper's authors, Cynthia Wu and Dora Xia, have made their shadow rate publicly available. In fact, they write that all researchers have to do is "...update their favorite [statistical model] using the shadow rate for the ZLB period."

That's just what we did. We took five of our favorite models (Bayesian vector autoregressions, or BVARs) and spliced in the shadow rate starting in 1Q 2009. The shadow rate is currently hovering around minus 2 percent, suggesting a more accommodative environment than what the effective fed funds rate (stuck around 15 basis points) can deliver. Given the extra policy accommodation, we'd expect to see a bit more growth and a lower unemployment rate when using the shadow rate.

Before showing the average forecasts that come out of our models, we want to point out a few things. First, these are merely statistical forecasts and not the forecast that our boss brings with him to FOMC meetings. Second, there are alternative shadow rates out there. In fact, St. Louis Fed President James Bullard mentioned another one about a year ago based on work by Leo Krippner. At the time, that shadow rate was around minus 5 percent, much further below Wu and Xia's shadow rate (which was around minus 1.2 percent at the end of last year). Considering the disagreement between the two rates, we might want to take these forecasts with a grain of salt.

Caveats aside, we get a somewhat stronger path for real GDP growth and a lower unemployment rate path, consistent with what we'd expect additional stimulus to do. However, our core personal consumption expenditures inflation forecast seems to still be suffering from the dreaded price-puzzle. (We Googled it for you.)

Perhaps more important, the fed funds projections that emerge from this model appear to be much more believable. Rather than calling for an immediate liftoff, as the standard approach does, the average forecast of the shadow rate doesn't turn positive until the second half of 2015. This is similar to the most recent Wall Street Journal poll of economic forecasters, and the September New York Fed survey of primary dealers. The median respondent to that survey expects the first fed funds increase to occur in the third quarter of 2015. The shadow rate forecast has the added benefit of not being at odds with the current threshold-based guidance discussed in today's release of the minutes from the FOMC's October meeting.

Moreover, today's FOMC minutes stated, "modifications to the forward guidance for the federal funds rate could be implemented in the future, either to improve clarity or to add to policy accommodation, perhaps in conjunction with a reduction in the pace of asset purchases as part of a rebalancing of the Committee's tools." In this event, the shadow rate might be a useful scorecard for measuring the total effect of these policy actions.

It seems that if you want to summarize the stance of policy right now, just maybe...the shadow knows.

Photo of Pat HigginsBy Pat Higgins, senior economist, and


Photo of Brent MeyerBrent Meyer, research economist, both of the Atlanta Fed's research department

November 20, 2013 in Fed Funds Futures, Federal Reserve and Monetary Policy, Forecasts, Interest Rates, Monetary Policy | Permalink


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'The shadow rate ... is estimated using Treasury forward rates out to a 10-year horizon.'

The Wu-Xia paper mentions forward rates, but it also describes a three-factor model incorporating 97 different macro series.

Since June 2013, the shadow policy rate has declined from -0.80% to a series-low -1.98%, while forward rates have been rising.

Is this sharp decline in the shadow policy rate due to changes in the macro series (e.g. accelerating GDP growth, to name one example), changes in forward rates, or both?

Posted by: Jim Haygood | January 13, 2014 at 04:45 PM

This has to be wrong, or a bad construct. Any full forward rate measure shows positive rates until you get to the far end of the yield curve.

Posted by: David Merkel | March 16, 2015 at 05:56 AM

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August 19, 2013

Does Forward Guidance Reach Main Street?

The Federal Open Market Committee (FOMC) has been operating with two tools (well described in a recent speech by our boss here in Atlanta). The first is our large-scale asset purchase program, or QE to everyone outside of the Federal Reserve. The second is our forward guidance on the federal funds rate. Here’s what the fed funds guidance was following the July FOMC meeting:

[T]he Committee decided to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6-1/2 percent, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee's 2 percent longer-run goal, and longer-term inflation expectations continue to be well anchored. 

The quarterly projections of the June FOMC meeting participants give more specific guidance on the fed funds rate assuming “appropriate” monetary policy. All but one FOMC participant expects the funds rate to be lifted off the floor in 2015, with the median projection that the fed funds rate will be 1 percent by the end of 2015.

But forward guidance isn’t worth much if the public has a very different view of how long the fed funds rate will be held near zero. The Federal Reserve Bank of New York has a good read on Wall Street’s expectation for the federal funds rate. Its June survey of primary dealers (a set of institutions the Fed trades with when conducting open market operations) saw a 52 percent chance that the fed funds rate will rise from zero in 2015, and the median forecast of the group saw the fed funds rate at 0.75 percent at the end of 2015. In other words, the bond market is broadly in agreement with the fed funds rate projections made by FOMC meeting participants.

But what do we know about Main Street’s perspective on the fed funds rate? Do they even have an opinion on the subject?

Our perspective on Main Street comes from our panel of businesses who participate in the monthly Business Inflation Expectations (BIE) Survey. And we used our special question to the panel this month to see if we could gauge how, indeed whether, businesses have opinions about the future of the federal funds rate. Here’s the specific question we put to the group:

Currently the fed funds rate is near 0%. [In June, the Federal Reserve projected the federal funds rate to be 1% by the end of 2015.] Please assign a percentage likelihood to the following possible ranges for the federal funds rate at the end of 2015 (values should sum to 100%).

In the chart below, we plot the distribution of panelists’ median-probability forecast (the green bars) compared to the distribution of the FOMC’s June projection (we’ve simply smushed the FOMC’s dots into the appropriately categorized blue bars).

Seventy-five percent of our respondents had a median-probability forecast for the fed funds rate somewhere between 0.5 percent and 1.5 percent by the end of 2015. That forecast compares very closely to the 73 percent of the June FOMC meeting participants.

You may have noticed in the above question a bracketed bit of information about the Federal Reserve’s forecast for the federal funds rate: “In June, the Federal Reserve projected the federal funds rate to be 1% by the end of 2015.” Actually, this bit of extra information was supplied only to half of our panel (selected at random). A comparison between these two panel subsets is shown in the chart below.

These two subsets are very similar. (If you squint, you might see that the green bars appear a little more diffuse, but this isn’t a statistically significant difference…we checked.) This result suggests that the extra bit of information we provided was largely extraneous. Our business panel seems to have already had enough information on which to make an informed prediction about the federal funds rate.

Finally, the data shown in the two figures above are for those panelists who opted to answer the question we posed. But, at our instruction, not every firm chose to make a prediction for the federal funds rate. With this month’s special question, we instructed our panelists to “Please feel free to leave this question blank if you have no opinion.” A significant number of our panelists exercised this option.

The typical nonresponse rate from the BIE survey special question is about 2 percent. This month, it was 22 percent—which suggests that an unusually high share of our panel had no opinion on the future of the fed funds rate. What does this mean? Well, it could mean that a significant share of Main Street businesses are confused by the FOMC’s communications and are therefore unable to form an opinion. But a high nonresponse rate could also mean that some segment of Main Street businesses don’t believe that forward guidance on the fed funds rate affects their businesses much.

Unfortunately, the data we have don’t put us in a very good position to distinguish between confusion and apathy. Besides, we’re optimistic sorts. We’re going to emphasize that 78 percent of those businesses we surveyed responded to the question, and that typical response lined up pretty well with the opinions of FOMC meeting participants and the expectations of Wall Street. So, while not everyone is dialed in to our forward guidance, Main Street seems to get it.

Photo of Mike BryanBy Mike Bryan, vice president and senior economist,

Photo of Brent MeyerBrent Meyer, economist, and

Photo of Nicholas ParkerNicholas Parker, senior economic research analyst, all in the Atlanta Fed's research department

August 19, 2013 in Business Inflation Expectations, Economics, Fed Funds Futures, Federal Reserve and Monetary Policy | Permalink


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Forward guidance can prove to be an effective tool for monetary policy, especially, when it is first implemented, as it is unexpected as well. Later on, however, its impact is diminished as it is only the change in expected guidance that might have an impact.

Posted by: Javier | September 21, 2013 at 11:50 AM

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March 08, 2013

Will the Next Exit from Monetary Stimulus Really Be Different from the Last?

Suppose you run a manufacturing business—let's say, for example, widgets. Your customers are loyal and steady, but you are never completely certain when they are going to show up asking you to satisfy their widget desires.

Given this uncertainty, you consider two different strategies to meet the needs of your customers. One option is to produce a large quantity of widgets at once, store the product in your warehouse, and when a customer calls, pull the widgets out of inventory as required.

A second option is to simply wait until buyers arrive at your door and produce widgets on demand, which you can do instantaneously and in as large a quantity as you like.

Thinking only about whether you can meet customer demand when it presents itself, these two options are basically identical. In the first case you have a large inventory to support your sales. In the second case you have a large—in fact, infinitely large—"shadow" inventory that you can bring into existence in lockstep with demand.

I invite you to think about this example as you contemplate this familiar graph of the Federal Reserve's balance sheet:


I gather that a good measure of concern about the size of the Fed's (still growing) balance sheet comes from the notion that there is more inherent inflation risk with bank reserves that exceed $1.5 trillion than there would be with reserves somewhere in the neighborhood of $10 billion (which would be the ballpark value for the pre-crisis level of reserves).

I understand this concern, but I don't believe that it is entirely warranted. My argument is as follows: The policy strategy for tightening policy (or exiting stimulus) when the banking system is flush with reserves is equivalent to the strategy when the banking system has low (or even zero) reserves in the same way that the two strategies for meeting customer demand that I offered at the outset of this post are equivalent.

Here's why. Suppose, just for example, that bank reserves are literally zero and the Federal Open Market Committee (FOMC) has set a federal funds rate target of, say, 3 percent. Despite the fact that bank reserves are zero there is a real sense in which the potential size of the balance sheet—the shadow balance sheet, if you will—is very large.

The reason is that when the FOMC sets a target for the federal funds rate, it is sending very specific instructions to the folks from the Open Market Desk at the New York Fed, who run monetary policy operations on behalf of the FOMC. Those instructions are really pretty simple: If you have to inject more bank reserves (and hence expand the size of the Fed's balance sheet) to maintain the FOMC's funds rate target, do it.

To make sense of that statement, it is helpful to remember that the federal funds rate is an overnight interest rate that is determined by the supply and demand for bank reserves. Simplifying just a bit, the demand for reserves comes from the banking system, and the supply comes from the Fed. As in any supply and demand story, if demand goes up, so does the "price"—in this case, the federal funds rate.

In our hypothetical example, the Open Market Desk has been instructed not to let the federal funds rate deviate from 3 percent—at least not for very long. With such instructions, there is really only one thing to do in the case that demand from the banking system increases—create more reserves.

To put it in the terms of the business example I started out with, in setting a funds rate target the FOMC is giving the Open Market Desk the following marching orders: If customers show up, step up the production and meet the demand. The Fed's balance sheet in this case will automatically expand to meet bank reserve demand, just as the businessperson's inventory would expand to support the demand for widgets. As with the businessperson in my example, there is little difference between holding a large tangible inventory and standing ready to supply on demand from a shadow inventory.

Though the analogy is not completely perfect—in the case of the Fed's balance sheet, for example it is the banks and not the business (i.e., the Fed) that hold the inventory—I think the story provides an intuitive way to process the following comments (courtesy of Bloomberg) from Fed Chairman Ben Bernanke, from last week's congressional testimony:

"Raising interest rate on reserves" when the balance sheet is large is the functional equivalent to raising the federal funds rate when the actual balance sheet is not so large, but the potential or shadow balance sheet is. In both cases, the strategy is to induce banks to resist deploying available reserves to expand deposit liabilities and credit. The only difference is that, in the former case, the available reserves are explicit, and in the latter case they are implicit.

The Monetary Policy Report that accompanied the Chairman's testimony contained a fairly thorough summary of costs that might be associated with continued monetary stimulus. Some of these in fact pertain to the size of the Fed's balance sheet. But, as the Chairman notes in the video clip above, when it comes to the mechanics of exiting from policy stimulus, the real challenge is the familiar one of knowing when it is time to alter course.

Photo of Dave AltigBy Dave Altig, executive vice president and research director of the Atlanta Fed


March 8, 2013 in Banking, Fed Funds Futures, Federal Reserve and Monetary Policy, Monetary Policy | Permalink


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One potential risk this time is that the Fed has been buying lots of assets that aren't treasuries, and some of the riskier assets can no longer be sold for the same price at which it was bought. In theory that situation could leave the Fed unable to recall all the money it put into circulation.

That said, you are right that interest on reserves could still be raised to have the same effects.

Posted by: Matthew Martin | March 08, 2013 at 03:30 PM

"In both cases, the strategy is to induce banks to resist deploying available reserves to expand deposit liabilities and credit."

Banks cannot lend their reserves. In fact, there is no balance sheet transaction that will allow a central bank liability to be loaned to a "non-bank" entity. Banks make loans by issuing a demand deposit and not by issuing reserves. Bank lending is never constrained by a reserve position.

The IoER policy implemented in 2008 moved the Federal Reserve out of a "corridor system" and into a "floor system". Under a floor system the level of reserves and the overnight interest rate are divorced. The IoER or "floor level" also becomes the deposit level. This disconnect works as long as there are sufficient excess reserves within the system, which in the case of the US, there are adequate excess reserves.

It should also be noted that future increases in the overnight rate are simply announced with the lending and deposit rates changing in tandem. Traditional models of draining reserves via FOMO are no longer required. Reserves are not the dual of overnight interest rates. Thus, when the Fed would like to "tighten" policy it will not be required to reduce the size of it's balance sheet as draining operations are no longer required to hit the overnight target.

Posted by: JJTV | March 08, 2013 at 05:58 PM

How about changing how monetary policy is conducted? Instead of using the blocked and saturated credit markets for monetary policy just bypass them and modify the fed so it deals directly with the public.


Posted by: Daniel | March 09, 2013 at 12:55 AM

If the fed marks up its long position and passes the gain to the treasury wont it have to pass the loss when it hikes the fed rate? and what will be the impact to treasurys when it hikes the fed rate? wont it raise the cost to the government budget when rates go up and it has to finance the debt at 110% debt to gdp and a duration of less than 5 thanks to the fed? Aren't we underestimating the potential damage to hiking rates?

Posted by: Emilio Lamar | May 01, 2013 at 02:33 PM

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January 06, 2012

In the interest of precision

As you may have heard, the minutes of the December 13 meeting of the Federal Open Market Committee (FOMC) contained the news that, starting with this month's meeting, committee members will be jointly publishing not only their personal projections for gross domestic product growth, unemployment, and inflation, but also the monetary policy assumptions that underlie those forecasts. In an article published earlier this week, the enhancement to these projections, known as the Summary of Economic Projections (SEP), was described in the Wall Street Journal this way (with my emphasis added):

"Federal Reserve officials this month will begin detailing their plans for short-term interest rates, a move that could show that the central bank's easy-money policies will remain in place for years and give the economy a boost."

A similar description appeared in the Journal yesterday (again, emphasis added):

"The Fed has just taken a historic step towards increasing its transparency and accountability by saying it will begin to release interest-rate projections several years out at the conclusion of its next policy meeting on Jan. 25. This means Fed officials will soon let the world know exactly what path they believe interest rates will follow—and they, after all, set the path of interest rates."

I added the emphasis in both of those passages because I think the highlighted language isn't quite right. Here is the actual language that appears in the FOMC minutes:

"In the SEP, participants' projections for economic growth, unemployment, and inflation are conditioned on their individual assessments of the path of monetary policy that is most likely to be consistent with the Federal Reserve's statutory mandate to promote maximum employment and price stability, but information about those assessments has not been included in the SEP.…

"… participants decided to incorporate information about their projections of appropriate monetary policy into the SEP beginning in January. Specifically, the SEP will include information about participants' projections of the appropriate level of the target federal funds rate in the fourth quarter of the current year and the next few calendar years, and over the longer run; the SEP also will report participants' current projections of the likely timing of the first increase in the target rate given their projections of future economic conditions."

The minutes are pretty clear about what this information is intended to convey…

"Most participants agreed that adding their projections of the target federal funds rate to the economic projections already provided in the SEP would help the public better understand the Committee's monetary policy decisions and the ways in which those decisions depend on members' assessments of economic and financial conditions."

…and what it is not intended to convey (here too, emphasis added):

"Some participants expressed concern that publishing information about participants' individual policy projections could confuse the public; for example, they saw an appreciable risk that the public could mistakenly interpret participants' projections of the target federal funds rate as signaling the Committee's intention to follow a specific policy path rather than as indicating members' conditional projections for the federal funds rate given their expectations regarding future economic developments. Most participants viewed these concerns as manageable…"

In fact, the first Journal piece mentioned above does document some of the expressed concerns near the end of the article. For example:

"… some might mistakenly see the forecasts as an ironclad commitment, rather than a projection that could change as economy evolves."

That caveat does speak to concerns of some FOMC participants that the projections would establish a specific policy path. But the issue is about more than maintaining flexibility in the face of changing economic conditions. The broader point is that the new information in the SEPs, according to the minutes, is not intended to be a device for signaling the policy path that the FOMC, by official vote, intends to pursue.

This may seem like a small detail. But when it comes to the central bank's communications tools, even the small details matter.

David AltigBy Dave Altig, senior vice president and research director at the Atlanta Fed


January 6, 2012 in Fed Funds Futures, Federal Reserve and Monetary Policy, Interest Rates, Monetary Policy | Permalink


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It's a forecast of policy, notwithstanding a current conditional commitment to hold policy steady.

Tricky time for implementation.

Posted by: JKH | January 07, 2012 at 06:32 PM

A key unintended consequence of this will be that everyone will be able to see, by comparing the evolving history of forecasts-vs-subsequent data, which members of the FOMC are actually decent economic forecasters and which are charlatans.

This may not bode well for public faith in the Federal Reserve.

Posted by: Wisdom Seeker | January 10, 2012 at 07:52 PM

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January 25, 2007

Do-It-Yourself Funds Rate Probabilities

If you are reading this, chances are you are familiar with these pictures depicting what the future (or the Federal Open Market Committee) might bring for the federal funds rate, as estimated from options of fed funds futures:






These used to be a regular feature here at macroblog, and have for some time been available daily at the Federal Reserve Bank of Cleveland's website.  They still are, but now the Cleveland site also has a new feature that allows you to customize the estimates, selecting how many alternative rate options you want to consider, whether to include a term premium, and if so how big you want that premium to be.  Knock yourself out. 

January 25, 2007 in Fed Funds Futures | Permalink


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I like this piece of information about the implied probs. I wonder whether something similar exists for the ECB?

Posted by: Manfred Jaeger | January 26, 2007 at 03:58 AM

Hi Manfred -- Not that I know of. But I'll keep my eyes open.

Posted by: Dave Altig | January 28, 2007 at 09:05 AM

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November 29, 2006

And So It Begins?

From the Financial Times:

Last week was significant in that the dollar breached an important barrier, according to traders. Since May, it had been relatively stable within a euro trading range of $1.25-$1.30. Its fall outside this range left investors wondering whether that was simply due to a lack of liquidity around the Thanksgiving holiday or the start of a more sustained slide in the US currency...

An even bigger concern is growing talk of global central banks diversifying their foreign exchange reserves away from the US currency. One factor supporting the dollar has been huge purchases by foreign central banks. Since 2001, global currency reserves have soared from $2,000bn to $4,700bn according to the IMF, with two-thirds of the world's stockpiles held by six countries: China, Japan, Taiwan, South Korea, Russia and Singapore.

Anxieties over reserve diversification have been around for at least six months, with central banks in Russia, Switzerland, Italy and the United Arab Emirates announcing plans to cut the proportion of dollars held in their reserves. A shift by central banks away from dollars would remove a key source of financing for the US deficit...

Fan Gang, director of China's National Economic Research Institute and a member of China's monetary policy committee, saw things differently. He said the real problem the world faced was an overvalued dollar, not only against the renminbi but against all the leading currencies.

His comments come at a time when speculation is increasing that China, which is thought to hold 70 per cent of its foreign currency stockpile in dollars, is considering a fundamental change in its reserve allocation. These concerns were highlighted on Friday when Wu Xiaoling, deputy governor of the People's Bank of China, said Asian foreign exchange reserves were at risk from the dollar's fall.

And there is this (hyperlink added):

... Market expectations, monitored by the Federal Reserve Bank of Cleveland, show that investors think there is a 30 per cent chance of a cut in US rates in March.

Just as it seems interest rates in the US may have peaked, they are being increased by the European Central Bank, the Bank of England and the Bank of Japan. The ECB is expected to raise its main rate from 3.25 per cent to 3.5 per cent at its December 7 meeting. The big question is whether Jean-Claude Trichet, ECB president, will signal further increases in 2007.

Here's something to think about.  If the move away from the dollar is for real -- with the presumably inevitable result that current account deficits will not continue to support domestic spending in the United States -- the result will almost certainly be higher U.S. interest rates.  Here's a position, which I endorse, about what that might mean for monetary policy:

We believe that changes in the federal funds rate should be considered on the basis of where economic forces are taking market interest rates, a perspective stemming from several presumptions about the way our economy works. First, “a balance between the quantity of money demanded and the amount the central bank supplies” requires the federal funds rate to adjust roughly in alignment with changes in real—that is, inflation-adjusted—returns to capital.

In other words, if long-term real interest rates rise, monetary policy becomes more expansionary even if the federal funds rate doesn't change.  (This is roughly behind the idea of associating "easy" monetary policy with a steep yield curve, and "tight" policy with a flat yield curve.) That is worth keeping in mind as you read stories like this one:

In another volatile day on the currency markets, the dollar recovered some poise against the euro on Wednesday after an unexpectedly large upward revision to US growth 2.2 per cent in third quarter against an estimated 1.6 per cent and consensus forecasts of a 1.8 per cent rise...

Speaking in New York overnight, Mr Bernanke struck a hawkish tone on US interest rates, saying that inflation in the US remained “uncomfortably high”.

Analysts said that, while it might be something of a surprise that the dollar had failed to derive support from Mr Bernanke’s remarks, he might be in danger of “crying wolf” over US inflationary pressures.

You know, sometimes the wolf is really there.

November 29, 2006 in Exchange Rates and the Dollar, Fed Funds Futures, Federal Reserve and Monetary Policy | Permalink


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Hi Dave,

The reason the USD is going down, and didn't respond to Greenspan, oops, i mean Bernanke (!), is the ongoing adjustment in the US property market. This process has only just begun, not in terms of starts, but in terms of housing competions, which are still near highs. Hence, employment in construction is still high, though with starts down, it has flattened out.

This means that the employment effect is coming in 2007. How big will it be? Who knows (I think bad, but i've been wrong many times before!).

But, what we do know is that, ahead of this process, and with the USD near all time lows, a bad outcome could leave the USD without a rudder and send it tumbling. That's a risk that justifies reducing exposure, or as we do it in hedgefund land, selling the USD.

We also know one other thing. The FED will likely take their time to ease. This process should be a good deal slower than after the stock market crash in 2000. That effect was fast and furious, and the FED a bit slow. Unlike today, the U-rate bottomed in April, the month after stocks turned down. And, the first negative emp report was in June that year. Emp growth has slowed, but it is still positive this time.

So, the longer the process takes, the greater the potential for a nastier eventual outcome. The higher rates stay, the bigger the eventual pressure on housing.

That's why, when Bernanke suggests he is still worried about inflation, the USD didn't bounce. A rate hike, or delay in cuts (as I expect), eventually makes the property adjustment worse not better. And, the downside risks to the USD that much higher.

I hope this helps give a glimpse of how some from the speculative side of the FX arena looks at this issue.


Posted by: andres | November 29, 2006 at 04:15 PM

I personally disagree with Andres, although I'm no expert in the arena. It looks to me as if cost-push inflation is coming in the next few months, with rising wages and little to no increase in productivity. If this occurs with no intervention from the FED to raise interest rates, the USD will slip and, given enough time, foreign bodies will begin to sell their USD, furthering any economic woes the US would have at that point. Of course, I could be entirely wrong on that.


Posted by: Cyrus | November 29, 2006 at 05:46 PM

I agree, the wolf is out there; AG let him out of his cage and he's running loose on Wall ST. Those with kids & grandkids should be very concerned, he eats his young.

Posted by: bailey | November 29, 2006 at 06:31 PM

hahaha, i agree with both of you! Cyrus, it is possible wage inflation will lead to more price inflation.

but, in this case, the outlook for property, and assets in general canget very ugly. higher rates will impinge on property demand at a time of high supply; higher inflation will challenge asset values which are premised on low inflation and low rates. Yikes!

Your case makes the USD look worse, not better.

that's why selling it seems the really good trade, rather than taking a strong view on the outlook for interest rates!

woof woof

Posted by: andres | November 29, 2006 at 08:49 PM

"We believe that changes in the federal funds rate should be considered on the basis of where economic forces are taking market interest rates, a perspective stemming from several presumptions about the way our economy works. First, “a balance between the quantity of money demanded and the amount the central bank supplies” requires the federal funds rate to adjust roughly in alignment with changes in real—that is, inflation-adjusted—returns to capital."

i can clap to this.

it does make some sense to use a moving average or rate of change of the long term yield to at least be a part of the calculation that determines monetary policy.

the bond market is large enough that price/yield manipulation would be difficult to achieve; but something tells me the goldman sachs/hedge funds of the world would still try in order to get access to cheaper capital/liquidity.

but still, i think it's an interesting suggestion...

Posted by: m3 | November 29, 2006 at 11:10 PM

Just look at those Texas janitors getting a 50% (f-i-f-t-y) [That's FIVE, ZERO] pay hike after only a month of bargaining and you know wage inflation is more than andres, Ben and GOD-knows-WHO say it is.
Rates will have to rise to contain this tsunami of inflationary wages and we will just have to face the consequences for the housing market. Those dummies who bought ARMs and sub-primes can go back to camping. Cry me a river, this is about keeping the buck from becoming buckshot.
Interesting amount of foreign relations being conducted by US diplomats at the moment --did Condi take a vacation or what? Most notably Bernanke and Paulson off soon to China on a trade mission, or was that a currency mission? a banking mission? Something.

Posted by: calmo | November 29, 2006 at 11:20 PM

Always remember to check the revisions in any of the horribly skewed financial releases.

Wage compensation has been revised - Compensation up 1.4%, not 7.4%


This maybe another reason the dollar is on its downward spiral. I have a feeling when the revisions for GDP come out, another downward "surprise" will be lurking.

This is not to say that there shouldn't be liquidity/inflation worries, but to enhance them as Bernanke lowers rates soon and does more one day 22 billion dollar coupon passes.

With vendor financing via China and petrodollars looking like bad ROI as the US consumer fades, I expect a greater dollar loss.

Posted by: Alan Greenspend | November 30, 2006 at 08:58 AM

It sure looks like BB's been played like Charlie Brown since the day he signed on. More & more he's looking like a nice guy on a field full of Lucys, unable to apply reason in a world run by rules he doesn't "get".
First, he gets sucker-punched by a dufus cnbc reporter. Then, he takes someone's advice to forget he's always been a straight-shooter, that we all want him to talk gibberish. Then, for some unknown reason he approves an all but toothless credit guidance to his Banks AFTER they publicly confess to absurdly loose lending practices. And now, it's the BEA's turn to pull the football away with a casual oops.
BEA's under Commerce, it's mission is “to foster, promote, and develop the foreign and domestic commerce” of the United States." THEIR job is to help business do more business. Even I know Commerce is just as political as the RNC. So, why is our FED Head "trusting" them, unchecked, to present a credible representation of anything?
On housing, BB has commented that price increases were "driven by fundamentals". He hasn't asked Congress or used his pulpit to call for greater regulatory control over our financial sector, post Glass-Steagall.
He hasn't even cautioned markets not to overread his professed belief that a lot of economic ills can be cured with printing presses. Obviously, the markets are betting big time that Ben will "work" with them.
In a statement last March on the challenges hedge funds present, BB argued that market discipline can work but counterparty risk management is concerning. Concerning? What's the growth rate of credit derivatives? Is anyone reassured because BB's going to China with Hank?
Dave's wonderful Cleveland Fed link ended with a great closing line: "Credibility is the currency of central banks." We ALL trust in the FED to identify and act on the REAL threats to our longterm economic wellbeing. If the scope is now outside FED mandate, we trust it to argue for new regulatory controls. My simple question for BB is, if we can't trust the FED to act for our LONGTERM economic viability, what are our prospects? Personally, I take no solice that BB's going to China with Hank. It's the Administration's & Congress' profligate policies & practices that got us here & it's folly to think there's a win in this for the FED. I just wish BB would learn, the Lucys in his world NEVER change.

Posted by: bailey | November 30, 2006 at 11:31 AM

Well the U.S.A. has a problem: it needs to maintain offshore confidence in the USD so foreign investors will keep providing the cash to fund the U.S. Federal Government Deficit. In this environment the U.S. can't really afford to ease, even if the U.S. economy is going down the toilet. The external constraint is too great.

It's a very fine tight rope to walk and sooner or later they are gonna trip over.

Posted by: Paris_Ib | November 30, 2006 at 01:34 PM

Bailey asks a question of BB: "if we can't trust the FED to act for our LONGTERM economic viability, what are our prospects?"

My question is similar, but twisted to read: "How can we (why should we?) trust the FED to act for our LONGTERM economic viability?" This I ask because the FED keeps coming up with (and being proud of) documents like the one Dave linked us to above that ask us pretty much to "trust them." After all they "are" the experts, no?

We'll I don't trust physicians, engineers, economists or pretty much any of the too-arrogant professional classes. What I want to know from them is what they intend to do when faced with difficult choices (policy and other) and then be able to make my choices accordingly.

What I read from the afformentioned paper http://www.clevelandfed.org/Annual01/essay.pdf was that "central banks ultimately can deliver more economic growth by abandoning preoccupaiton with output gaps (and the like) in favor of a price-stability rhetoric and a policy orientation that meets this objective with the least interference to the natural, dynamic forces of the econmy."

Good luck when the FED seems incapable of even admitting to asset inflation, let alone admitting any complicity in such. I'm probably in a distinct minority, but I trust the ECB more than I do the FED. Or maybe I just don't know enough about the ECB to not trust their rhetoric or policy either.

Posted by: Dave Iverson | November 30, 2006 at 05:30 PM

The notion that higher long rates mean more accommodative monetary policy is counter-intuitive. That doesn't mean it isn't true, but it needs more than a suggestion to be pursuasive.

Posted by: kharris | December 01, 2006 at 09:56 AM

I can't help but keep harping that we'd ALL be a LOT better off today had Congress listened to Katharine Abraham instead of AG. Here's a Dean Baker post that makes the point better than I'm capable of doing.
But, on to today. I appeal to the BB because this Administration, Congress AND current Democratic leadership have ALL convinced me the FED's the only thing between us & a disastrous economic meltdown. Recognizing we're a LONG way from FED transparency, I'd love to hear BB read Dave's linked Cleveland Fed piece verbatum to our financial center moguls. In fact, I'd love to hear BB speak to our long-term prospects, any time, any way he chooses.
I can't fathom a way out of the financial hole we've dug for ourselves except to take our medicine & get back to work. A great first step would be for BB to start explaining to the markets why they've made a terrible bet that he's as short-sighted as they are.

Posted by: bailey | December 01, 2006 at 11:38 AM

The dollar has fallen over the past couple of weeks because foreign central banks and monetary authorities have changed their behaviour. Instead of passively rebalancing their reserve portfolios, like they did all summer, they have indeed stepped up their net sales of dollars against G10 currencies substantially.

This is an annual phenomenon and is unlikely to spell the death of the dollar, as this type of activity generally moderates in the new year.

The notion that the US government will be up the creek if foreign central banks don't want so many dollars is likely to be flawed.

If the dollar is finally allowed to adjust against Asian and oil-exporting reserve accruers, then the current account deficit will shrink and there is unlikely to be the need to attract as much foreign capital to the US.

This has yet to happen, however. Several Asian central banks (notably the MAS in Singapore)intervened very heavily last week.

This, of course, begs the question: if these guys don't like the dollar, then why do they buy so many?

Posted by: Macro Man | December 02, 2006 at 11:27 AM

Yes it does beg the question. And I'm sure they are asking themselves the very same thing. In fact the recent (weak) performance of the USD suggests that the Central Banks are not coming up with a very good answer. Why do we like USDs? No idea. So perhaps they stop buying. In fact the Central Banks of the world don't even have to sell current USD denominated holdings to see the USD in serious trouble. That is: in even more trouble.

The Asian crisis and the building up of FX reserves by Foreign Banks which followed promoted the view that the U.S. will always have access to large capital inflows, no matter how bad economic and foreign policy leadership. Now we are testing the validity of that view. Which was based on intellectual laziness and arrogance more than anything else. The U.S. is not immune to the laws of economics and their is no natural reason why the USD should have International Reserve Currency Status. The impact of that change of scenario could be quite dramatic.

And all you have to do is just wait and see.....

Posted by: Paris ib | December 05, 2006 at 08:19 AM

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July 30, 2006

All Systems Stop

At midweek, Tim Duy wrote this at Economist's View:

Futures markets appear to have no clear conviction on the outcome of the next FOMC meeting. The message is that market participants are looking for one more rate hike, either in August or September. Moreover, they doubt the Fed’s position that “pause does not mean done.”

That was indeed the case then, but this is now.  Bringing you tomorrow's news today, here is what the probabilities estimated from options on federal funds futures look like as the week of before the next meeting of the Federal Open Market Committee begins:




Friday's second quarter GDP report really wasn't all that bad, but apparently not as good as expected was enough.  And Professor Duy was right -- the market does seem to doubt the Fed’s position that “pause does not mean done.”




It's still a relatively long time to September, but at this point it is hard to see what might significantly shift sentiment about this week's meeting.

UPDATE:  I take it back. Tomorrow's ISM and PCE reports could loom large.  And there was this, from Federal Reserve Bank of St. Louis president William Poole:

Federal Reserve Bank of St. Louis President William Poole said he's undecided on whether the central bank should raise interest rates at its next meeting in eight days.

Poole, speaking to reporters after a speech in Louisville, Kentucky, said he's "50-50'' on the decision, which needs "all our analytical skills.'' Recent data show slowing economic growth, while inflation has "tilted'' upward, he said. Containing inflation is the Fed's "primary'' goal, he added.

UPDATE II: Action Economics (subscription required) reports:

SF Fed's Yellen did note rule out more rate hikes though she said that the Fed funds rate is "in the vicinity" of the right level, noting the Fed remains responsive to the data and she expects below-trend growth later in 2006 to pull down inflation. Yellen also confirmed that the Fed was mindful of policy lags and even though core inflation is above her comfort zone, the Fed can pause before it begins to decline, while retaining a more restrictive policy setting... Overall the comments are fairly balanced and do not rule in or out another hike in August

July 30, 2006 in Fed Funds Futures | Permalink


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It does seem as though if the Fed pauses, it will be because they believe the data is pointing to a slowdown. If there is a slowdown there it won't be a pause, but a stop.

So if they believe the data shows a slowdown, then we would need to see strong subsequent data to cause a reversal of opinion. That's in sharp contrast to the attitude of the last 2 years, where the default position was to hike.

Posted by: Tom Graff | July 31, 2006 at 04:02 PM

It is hard for me to see why the fed wants to create all this uncertainty. They say they are forward looking but want to find out what next weeks data brings before they make up their minds. Is that a consistent position?

One thing we had when Gspan was running the fed was a fed bias. The fed would tell you if they are more biased towards hiking or easing. Bernanke has no bias -- so every meeting is essentially a guess for the markets.

Then you have the big white dove Yellen suggesting it may be prudent to pause in Aug in hike in Sep. LOL. Why not ease in Aug and hike 50bp in Sep?

Posted by: vincentm | July 31, 2006 at 09:30 PM

Meanwhile ..... the speculators are still pushing prices up, up, up as Janet chews on her foot.

The Fed better punish the poulation until those nasty hedge funds and super banks stop jacking inflation.

Posted by: quiz | August 01, 2006 at 12:28 AM

Personally, i'm more interested discussions of the combined effect of price inflation & wide open credit markets.
Check out Ca electric bill increases, for instance. Mine's up 60% yoy with only a 14% kwh usage increase. That put our last monthly bill at $350/month. But, don't worry for me, I'm making no spending adjustments to pay for it. I'm putting it on one of my 0% interest rate (thru mid 2007) credit cards.
On a not so separate topic, can you tell us if anyone at the Fed is looking into the effects from repealing Glass-Steagall?

Posted by: bailey | August 01, 2006 at 10:09 AM

There's something comical about Yellen suggesting that the current rate environment is "restrictive". Is 5.25% really "restrictive"? As a simple example let's say I borrow $100 IO (balloon and interest due at years end) for one year at 5.25%. My real cost at the end of the year for borrowing the $100 is only $.72 (using June '05-'06 CPI 4.3%.) It must be that my math skills are rusty, or most likely completely flawed, because that seems awfully close to free borrowing costs to me. I'd hazard a guess too that by the time you factor in the ubiquitous tax breaks for interest payments, it's perhaps even better than free. Can someone more mathematically gifted or economically insightful show me how 5.25% is "restrictive"?

Posted by: JS | August 01, 2006 at 11:10 AM

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July 20, 2006

Data Independence

This really is not much of a surprise, but I think this pattern of intraday probabilities estimated from fed-funds futures options is interesting:




There are plenty more more pictures in this spirit at Econbrowser

July 20, 2006 in Fed Funds Futures | Permalink


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June 30, 2006

Post-FOMC Market Update

The pudding, from the Financial Times..

“Traders probably sense from the statement that the Fed is proceeding cautiously, even reluctantly, in terms of future tightening,” said Alan Ruskin, strategist at RBS Greenwich Capital. “It seems like it may have caught the market off guard.”

Futures traders priced in a reduced probability of an August rate rise – still about 65 per cent cent, but down from about 90 per cent the day before.

... along with some more proof in pictures:




That change is not quite as dramatic as the numbers quoted from the Financial Times -- a result of using options rather than futures alone in the calculations of the probabilities -- but the story remains more or less the same. The details and data will be available later this morning on the Cleveland Fed website, where you will also find the first hint of what the market thinks September will bring:



UPDATE: Meanwhile, in the global blogger village: The Capital Spectator observes that the decision was "a surprise to no one", but the statement was "anything but routine."  (CS also digs up an analyst willing to muse "If we get a bad consumer price index report, for instance, the Fed might do something the next day".) The Nattering Naybob reads the statement as "status quo" (and puts the decision in the broader context of the day's news, as does The Skeptical Speculator.) But The Prudent Investor is not buying the dove interpretation.  William Polley thinks "another one or two quarter point steps are probably in the cards." Hypothetical Bias reminds us that "the Fed has a history of overdoing tightening regimes" and suggests that to "demonstrate his inflation-fighting credentials, Bernanke may continue this pattern." A full parsing of the Committe' statement is available at Economist's View and at The Mess That Greenspan Made.

The New Economist has some links that I missed.

Sort of related: Contango has an interesting panel of Morgan Stanley economists discussing whether monetary policy has defnitely turned restrictive. (Answer: Yes.)  Greg Mankiw relays (with some skepticism) an attempt to resurrect the reputation of Arthur Burns.

UPDATE II: Michael Shedlock has many thoughts, all of which lead to the conclusion that "the recession of 2007 is looming ever larger."

June 30, 2006 in Fed Funds Futures, Federal Reserve and Monetary Policy | Permalink


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Nice link to Contango, thanks. While you can add my name to those disbelieving (disdaining) our monetary aggregates, I'm not yet convinced our monetary policy's turned restrictive.
Prudentbear's Doug Noland posts an excerpt from a Kathleen Hays/Henry Kaufman interview in which HK questions wisdom of Fed's transparancy:
"the tendency for the Federal Reserve in recent years is to pursue two approaches: measured response and transparency .... That does not give you control over Credit creation. In the new financial markets ... when you tell an investment banking firm - a commercial banking firm – that it’s 25 basis points, there are many people who will analytically tell you what the risks are in the market along the interest-rate curve or in other Credit instruments, and will take the opportunity to leverage those positions and extend Credit."
In CA, free money's there for the taking, r.e. brokers are STILL hawking 0%int., 0 down mtgs, I'm beseiged daily with low/no interest (on balance transfer & purchases) credit card offerings, just a few days ago GM announced plans to reinstate its 0% interest auto buying program & durable goods retail stores are offering 0% interest out to 2008. Although anecdotal, these are hardly signs of a restrictive credit environment. I'd like to hear an Economist's thoughts about Kaufman's comments.

Posted by: bailey | June 30, 2006 at 10:13 AM

bailey -- I can't really give you an intelligent answer, because I don't really understand what Kaufmann has in mind. At the end of the day, the FOMC's control over credit extension is limited to its provision of reserves to the banking system. it is certainly true that a slower trajectory of rate increases will mean less restraint on reserfe creation than otherwise. But there is always a question of whether that represents the slow adjustment of the economy, or a slow adjustment of policy. Those two circumstances have very different imolications. Perhaps Mr. Kaufmann has something like "front-running" in mind -- that is, the tendency of credit providers to act speculatively (or not so speculatively) in front of expected rate changes. That certainly happens, but again this is limited to how the Desk decides to manage reserve postions.

Posted by: Dave Altig | July 01, 2006 at 09:35 AM

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June 15, 2006

No More Questions About The June FOMC Meeting

The aftermath of the inflation report on market expectations about what the FOMC will do next:




For the first time in our estimates, the probability that the funds rate target will be pushed to 5.5% by the time the August FOMC meeting is done exceeds the implied probability of a pause sometime this summer (if only by a little):



The details and the data will be available later this morning at the Federal Reserve Bank of Clevelandf website.

UPDATE: Calculated Risk agrees: "The June Fed Debate Appears Over".

June 15, 2006 in Fed Funds Futures, Federal Reserve and Monetary Policy, Inflation | Permalink


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I agree that the FED will raise rates at the next meeting in June, I jsut did a big analysis of the FED next moves on my blog.

It will be interesting to see what happens after that June 29.

There is a list of prominent names that have high forecasts for the next moves: Barclays with 6 % by year end, Lehman Brothers with a forecast of 5.75 per cent, JPMorgan and Credit Suisse, with a 6 per cent peak but both expect that rate some time next year.

Posted by: fxkingg | June 24, 2006 at 10:56 AM

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