Instant reaction: All hail Ben Bernanke!

1.  Fed does what it said it would do—make its decisions based on the data.  Good for them, and good for policy credibility.

2.  Stocks up sharply .  .  .  but wait, all the experts say QE doesn’t matter at zero rates.  Pushing on a string. Perfect substitutes, etc, etc.

3.  Bond yields down.  Yes, that goes against the view that the income and inflation effects usually trump the liquidity effects for long term bonds.  But consider:

a.  The level of the 10 year is still around 2.8%.  (Update: 2.76%, down 10 basis points.)  That’s the yield with no tapering at all.  What does that tell us? It tells us that very little of the run-up in yields since last year is due to expectations of tapering.  In other words, the Keynesians are right that QE means slightly lower yields right now, but people like Michael Darda are even more right; expectations about the future path of the economy are the major factor pushing up rates.  That doesn’t necessarily mean higher real growth expectations (the composition of growth also matters) but it probably does at least to some extent. This was a big natural experiment, and we just found out that very little of the more than 100 basis point run-up in yields was due to fear of tapering.

b.  It’s possible that due to market segmentation the QE purchases have more of a liquidity effect on the 10 year that ordinary OMOs during normal times.  But if so, doesn’t that mean QE is less likely to lead to a stock bubble than otherwise?  I.e. if markets are segmented then the “distortions” are more likely to be in the asset classes directly purchased by the Fed.  Or am I missing something?  (The risk of instant reaction.)

Update:  Lars Christensen was also proved right about the reason for rising bond yields–he said taper fears were not the driving force.  Here’s Lars:

Many have highlighted that the rise in US yields have been caused by the Federal Reserve’s plans to scale back quantitative easing. The fear of “tapering” is certainly a market theme and I would certainly not rule out that the tapering talk has contributed to the rise in bond yields. However, we don’t know that and a lot of other factors certainly also have contributed to the rise in yields and I certainly do not think that the recent rise in yields in itself is likely to derail the US economy.

Update:  I notice that yields took another sharp drop after 2:45, was there any news?


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43 Responses to “Instant reaction: All hail Ben Bernanke!”

  1. Gravatar of Arthur Arthur
    18. September 2013 at 10:27

    Brazilian stocks up 1% on the news. It seems tapper also hurts developing countries.

  2. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. September 2013 at 10:28

    “Stocks up sharply . . . but wait, all the experts say QE doesn’t matter at zero rates. Pushing on a string. Perfect substitutes, etc, etc.”

    Remember Scott, QE is just an asset swap. Thus this isn’t really happening. Obviously we must be stuck in the Monetary Realism version of the Matrix.

  3. Gravatar of Sam Sam
    18. September 2013 at 10:45

    I wonder how much an effect the possible/probable shutdown of the Federal gov. had on their decision?

  4. Gravatar of njk njk
    18. September 2013 at 10:46

    Why does lesson (a) follow? The market still anticipates that taper will eventually come, but it won’t be immediately.

    I guess I think it was BOTH fear of taper and expectation of the economy, but it’s hard to disentangle those two components because they coincided with the Fed announcing some pretty aggressive growth expectations AND the idea that it would taper if those expectations were met. All IIRC.

  5. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. September 2013 at 10:51

    Scott,
    Off topic but David Andolfatto has an interesting post on Japan that provoked a comment from me:

    http://andolfatto.blogspot.com/2013/09/whats-up-with-japan-g-evidently.html

    David Andolfatto:
    “What really stands out in this data, to my eye at least, is how G and I appear to have gone their separate ways.”

    It depends on what you mean by G.

    Japan uses the System of National Accounts (SNA) so government investment is included in I.

    If you look at the sum of government final consumption and public sector gross investment (what we call GCE in the US) you’ll notice there was one period since the “great slowdown” that GCE as a percent of nominal GDP (NGDP) significantly fell. This was from 25.0% of GDP in 2002Q1 to 22.3% of GDP in 2007Q2. In fact 22.3% is the smallest share of GDP that GCE has been on seasonally adjusted quarterly NGDP records back to 1994Q1. On unseasonally adjusted records one has to go back to 1992Q3.

    This happened primarily because public sector gross investment declined from 6.5% to 4.3% of nominal GDP. You can see from your graph that the decline in I as a proportion of GDP leveled off during this time. An examination of the components of I reveals that residential investment as a percent of GDP was also level during this time. And since inventories are volatile let’s exclude them as well.

    What we have left is private non-residential fixed investment (PNRFI). This rose from 12.7% of GDP in 2002Q2 to 15.3% of GDP in 2008Q2, which is easily the largest boom in this category since the great slowdown. In fact 15.3% is the largest share of GDP that PRNFI has been on seasonally adjusted quarterly NGDP records back to 1994Q1. On unseasonally adjusted records one has to go back to 1993Q1.

    Your second graph seems to show an anomaly that coincides with this decline in GCE and increase in PNRFI. This is the surge in real GDP (RGDP) growth from 2002Q1 to 2008Q1. During this time RGDP grew at an average annual rate of 1.9%. This compares to an average annual rate of 0.9% from 1992Q1 through 2002Q1.

    This period of resurgent growth is often referred to as the “Koizumi Boom” in Japan. Between 2002Q1 and 2008Q1 real (adjusted by the GDP implicit price deflator) GCE grew at only a 0.2% average annual rate. In contrast real PFNRI grew at an average annual rate of 4.7%. Real private consumption grew at the same rate as RGDP.

    A closer examination of Japan’s GDP reveals that both exports and imports surged during this time as well. Exports rose from 10.2% of nominal GDP in 2001Q4 to 19.3% of GDP in 2008Q3. Imports rose from 9.4% of GDP in 2001Q4 to 19.5% of GDP in 2008Q3. From 2002Q1 to 2008Q1 real (adjusted by the GDP implicit price deflator) exports grew at an average annual rate of 11.0%. Real imports grew at an average annual rate of 12.1%.

    David Andolfatto:
    “And, of course, the big question for monetary policy wonks: Is a massive asset-purchase program on the part of the Bank of Japan really what that economy needs?”

    Is there anything that can explain why Japanese RGDP (as well as real PNRFI, real exports and real imports) grew so fast despite the fact real GCE was stagnant during the Koizumi Boom? Well, there is the fact that Japan’s original ryōteki kin’yū kanwa (QE) was officially announced in March 2001 and concluded in March 2006.

    Just a coincidence?

  6. Gravatar of W. Peden W. Peden
    18. September 2013 at 10:59

    Mark A. Sadowski,

    Or markets are labouring under the illusion that QE matters, and they will come to realise the truth of MMR/MMT/PK/TGIF any day now… Any day now…

  7. Gravatar of o. nate o. nate
    18. September 2013 at 11:05

    In addition to the liquidity effect, there’s also the possibility that the market now expects short-term rates to remain low for a longer period of time, which would also lower longer-term bond yields.

  8. Gravatar of John Hall John Hall
    18. September 2013 at 11:05

    10 year yields are down to 2.68% (3:03pm), they were about 2.83% at the beginning of the day and hit a high close to 2.89% before the meeting.

    I think you’re making the story more complicated than it is. Investors realize that with no taper, then equity markets will rally. They sell bonds and buy stocks to take advantage, sending yields lower.

  9. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. September 2013 at 11:06

    Not a big surprise but the dollar is down 1.01% versus the euro, 1.04% versus the yen, and 1.24% versus the pound.

  10. Gravatar of Full Employment Hawk Full Employment Hawk
    18. September 2013 at 11:07

    “In a new set of quarterly forecasts, the Fed now sees growth in a 2 percent to 2.3 percent range this year, down from 2.3 percent to 2.6 percent in its June estimates. The downgrade for next year was even sharper: 2.9-3.1 percent from 3.0-3.5 percent.” Once again, the Fed’s forecast had predictably overestimated growth and made policy statements, that is, phasing out QE starting this Fall, on the basis of these overoptimistic forecasts. And the new ones are also predictably too high.

    The Fed’s forecasting errors have been consistently off in the same direction. The estimates for growth are too high and the estimates for unemployment are too low. Rational forecasters will use their forecasting errors to improve their forecasts, but the Fed does not seem to be willing or able to do this. Someone who is in a position to do it should develop a model to predict the forecasting errors of the Fed and use it to produce improved forecasts from the Fed’s forecasts.

  11. Gravatar of Jason Odegaard Jason Odegaard
    18. September 2013 at 11:07

    BB actually just said “We can’t let market reactions govern our monetary policy decisions”…..

    I may be paraphrasing a bit, I’ll have to get the transcript later.

    Perhaps he meant to say “We can’t let market expectations govern our monetary policy decisions”, which would make sense in a world where the Fed doesn’t really have any sort of reaction function to economic indicators. Which they don’t – they’re so vague. But all-in-all, that little phrase isn’t what one wants to hear if an NGDP futures market is where we want the Fed to get their monetary policy decision information from.

  12. Gravatar of njk njk
    18. September 2013 at 11:11

    I don’t think we’ve achieved the Fed’s growth targets for approximately 12 straight calendar years (according to our internal economist) so rational expectations should have adjusted on that front, but it clearly points out the superiority of allowing expectations to guide policy rather than making a guess about the economy, missing it, and allowing the market to guess what that means for policy.

  13. Gravatar of Mark A. Sadowski Mark A. Sadowski
    18. September 2013 at 11:15

    W. Peden,
    What does TGIF stand for? (Other than “Thank God It’s Friday”.)

    I’m still getting a handle MMR and new subsects are seemingly popping up all of the time. (And it seems to me if subsects are growing exponentially there’s something wrong with your economic model.)

  14. Gravatar of ssumner ssumner
    18. September 2013 at 11:23

    Sam, Monetary offset! I like it.

    njk, I think it’s pretty clear the market reaction was due to the lack of tapering, not the growth projections.

    Mark, Great comment.

    o nate. Yes, that’s sort of an “expected future liquidity effect.”

    John. Bond yields did fall 10 basis points on the news. I’d be interested if anyone knows why they took another dive after 2:45pm.

    Often an easy money announcement will cause both stocks and yields to rise. Why not this time?

    FEH. They are getting closer. Eventually they’ll end up at the 2% where I started the year.

    Jason, Hopefully he just meant that the Fed won’t have its hands tied by the expectations of Wall Street “experts.”

  15. Gravatar of ssumner ssumner
    18. September 2013 at 11:24

    njk, Yes, and to be clear it should be MARKET expectations guiding policy.

  16. Gravatar of John Hall John Hall
    18. September 2013 at 11:52

    Ah yes, I left out my point that market participants think that more QE will send bond yields lower in the near-term. This also caused a movement from cash into longer-term bonds, which drove down yields.

    Markets anticipated a taper. These expectations sent yields higher because markets view the near-term impact of QE as sending yields lower. When the taper no longer happened, yields undid part of the increase. You seem to think too much about the effect of the taper on aggregate demand and then aggregate demand on interest rates, but markets tend not to focus on that in the near-term.

  17. Gravatar of ssumner ssumner
    18. September 2013 at 11:55

    John Hall, You said;

    “You seem to think too much about the effect of the taper on aggregate demand and then aggregate demand on interest rates, but markets tend not to focus on that in the near-term.”

    That’s just false, there are plenty of cases where tight money lowered long term rates and vice versa. That can only happen via expectations of AD.

  18. Gravatar of No tapering, but no rule either. Net, net that is bad | The Market Monetarist No tapering, but no rule either. Net, net that is bad | The Market Monetarist
    18. September 2013 at 12:37

    [...] Scott Sumner is happy, but I must admit that I for once disagree with the Fed on the hawkish side (kind of). Not that I am not favouring monetary easing, but I don’t really think that the important thing is the amount of quantitative easing the Fed is doing in the sense of 10 or 20 billion dollars more or less per month relative to Fed communication. [...]

  19. Gravatar of John Hall John Hall
    18. September 2013 at 12:41

    To be clear, I’m not making any general claim about monetary policy and I’m not talking about loose or tight money. I’m making a limited claim: Since 2008, U.S. markets have behaved as if they were thinking that more QE means greater demand for bonds means lower yields, and vice-versa. Markets have not behaved as if they thought that more QE means higher yields by stimulating aggregate demand (which I do not deny is the important long-term mechanism).

  20. Gravatar of Brian Donohue Brian Donohue
    18. September 2013 at 12:44

    FWIW- today’s movement, like most of the movement in rates over the past four years, is almost entirely a “real” movement, not a change in expected inflation, which has pretty much stayed in the 1.5%-2.5% range since 2009. Not sure what this means, but judging by this post and comments, I’m not alone in my ignorance.

  21. Gravatar of JimP JimP
    18. September 2013 at 13:28

    To me this is all very lovely. Bernanke was very aggressive in saying that short rates will likely remain low even after unemployment has fallen in 2016. It is data dependent and the Fed finally sounds to me like they aggressively mean it – they are going to look at labor market conditions – including the participation rate – and they are not going to raise rates till they like what they see. It seems just wonderful – finally finally an openly aggressive Fed.

  22. Gravatar of kebko kebko
    18. September 2013 at 13:34

    By my model, today’s rates reflected a move back of about 1 month in the expected first rate hike, and a flattening of the yield curve after that point.
    TIPS spreads reflected the decrease in 10 year rates as mostly a change in the real rate.
    I don’t see how today’s movements vindicate the view that the taper wasn’t behind the summer rate increases. Markets seemed to expect a taper of maybe $20 billion a month to start, and the postponement of that by a month or two led to a 20bp decline in 5 year treasuries. I, for one, think that’s excessive. But it seems like a strong reaction to the taper.
    I estimate that 2017 Eurodollar futures, which declined by about 30bp, owe about 10bp to a delayed rate hike expectation and about 20bp to a flatter yield curve.
    I don’t see how the flatter yield curve can be justified based on the new looser monetary policy announcement, so this would appear to be a side product of the liquidity effect. I expect to see the yield curve re-steepen over the next couple of weeks, which, in effect, is saying, I don’t think bond markets are extremely efficient.
    That surprises me as much as the next guy, but doesn’t the hypothesis of a liquidity effect presuppose inefficiency?
    I was shorting Eurodollar futures like crazy today, so I’m doing my part – markets aren’t going to make themselves efficient.

  23. Gravatar of Jaap de Vries Jaap de Vries
    18. September 2013 at 13:47

    Actually, bernanke laid out that the tapering scale back will happen in a one year time frame. This means that, unless the economy improves quickly, will be for a large part in the hands of Ellen. Considering she is a greater dove than Bernanke this might change expectations of future monetary policy. Therefore I expect yields to go down further.

  24. Gravatar of Mike Freimuth Mike Freimuth
    18. September 2013 at 13:57

    What do you guys think would happen if not much changed in the economy between now and the next meeting and the Fed decided to increase QE to 95? (Presumably revising their forecasts down slightly).

  25. Gravatar of Essayist-Lawyer Essayist-Lawyer
    18. September 2013 at 14:33

    Actually, the falling interest rates could use some explanation. You have often quoted Milton Friedman as saying the high interest rates mean money has been too easy and low interest rates mean money has been too tight. I believed this, not because I think Milton Friedman is infallible holy writ, but because my lying eyes told me that every time the Fed announced a monetary expansion, interest rates responded by rising, and every time it ended an expansion, interest rates responded by falling.

    But this whole taper talk has gone against that bit of zen. Could you explore that further?

  26. Gravatar of James in London James in London
    18. September 2013 at 14:58

    I hear that bonds were bought some more a bit later as players began to worry that no tapering meant current conditions must be quite weak, or have turned weaker just recently, as some economic data has shown.

  27. Gravatar of Bob Murphy Bob Murphy
    18. September 2013 at 16:45

    Oh boy. Of course I have to respond to this one at my blog, Scott. It’s 1916 and we’re on opposite sides of the trenches. (I should be German for obvious reasons.) Nothing personal I hope you understand.

  28. Gravatar of EconPirate EconPirate
    18. September 2013 at 17:31

    What was your take on Bernanke’s “we can’t let market expectations dictate our policy actions”

  29. Gravatar of EconPirate EconPirate
    18. September 2013 at 17:32

    Nevermind, I see your reply to Jason

  30. Gravatar of Philippe Philippe
    18. September 2013 at 17:41

    Jaap de Vries, are you the artist Jaap de Vries?

  31. Gravatar of ssumner ssumner
    18. September 2013 at 18:19

    JimP, Here’s one area where the Fed is ahead of the real world. The Fed notices that PCE inflation is below target and likely to remain below target. The press COMPLETELY ignores that problem because their readers don’t want to hear about it. Bubbles are more fun.

    kebko, In my view expected QE policy is back to where it was before all the taper talk. It’s data driven. That was the original plan. That means most of the rise in bond yields was driven by the economy. Don’t make the mistake in assuming that the future path of expected short term rates describes Fed policy. It more likely predicts the economy. Maybe I need a post on that.

    Mike, That would certainly shock markets!

    Essayist-Lawyer. I have done posts, but don’t have all the answers. I’ve always argued that interest rates move unpredictably in response to monetary policy. Sometimes tight money raises rates and sometimes it lowers them. But one thing we know is that really, really tight money always lowers rates and really really easy money always raises them. Maybe I should do another post.

  32. Gravatar of kebko kebko
    18. September 2013 at 18:40

    Scott,

    I do expect future short term rates to predict the economy. That’s why I’m skeptical of a flatter yield curve.

    Also, I’d love to hear your response to my comment on the liquidity effect. Especially in today’s forward rate context, isn’t a liquidity effect a refutation of EMH?

  33. Gravatar of dtoh dtoh
    18. September 2013 at 20:27

    Scott, you said;

    “The level of the 10 year is still around 2.8%. (Update: 2.76%, down 10 basis points.) That’s the yield with no tapering at all. What does that tell us? It tells us that very little of the run-up in yields since last year is due to expectations of tapering. In other words, the Keynesians are right that QE means slightly lower yields right now, but people like Michael Darda are even more right; expectations about the future path of the economy are the major factor pushing up rates.”

    We have this discussion before. Fed OMP increases the immediate demand for financial assets pushing prices up. Increased NGDP expectations push down the price of financial assets. Changes in expected inflation also impact the real price and the nominal price of assets. Bottom line, you often can’t tell anything from day to days changes in nominal yields. It’s usually not even worth speculating.

    What is absolutely certain however, is that increased OMP will cause an increased exchange of financial assets for real goods and services. I.e. NGDP will go up. End of story.

  34. Gravatar of James in London James in London
    18. September 2013 at 21:19

    Of course, sleeping on it, you will think bond investors buying because they fear economic weakness contradicts equity investors buying because they expect lower rates for longer to turn out well. However, the two markets aren’t always so well connected.

    Sure there are asset allocators switching between bonds and equities. But, in the short run you more have equity investors switching between cash and equities, and have a separate dynamic in the bond market of investors there worrying more about duration, ie the near term shape of the yield curve.

    So, I heard market commentary at 2.30pm from the two markets as overwhelmingly separate discussions, very little was joined up. And fx/rates/credit departments worried about economic weakness, while equities teams cheered, unless they were short and had to scramble to cover.

  35. Gravatar of Jaap Jaap
    19. September 2013 at 01:54

    Philippe,

    I doubt that an artist is interested in the world of capitalism wrt to the details.

    My name is quite familiar in the Netherlands.

  36. Gravatar of Geoff Geoff
    19. September 2013 at 02:17

    “Lars Christensen was also proved right about the reason for rising bond yields–he said taper fears were not the driving force.”

    That’s not what he said. He said they might have been, but he doesn’t know.

    The recent drop in yields could be in response to Fed easing.

  37. Gravatar of Brian Donohue Brian Donohue
    19. September 2013 at 03:56

    “In my view expected QE policy is back to where it was before all the taper talk. It’s data driven. That was the original plan. That means most of the rise in bond yields was driven by the economy.”

    I dunno. On a daily basis, it seems obvious to tie the stark movement in rates to the taper talk. But the Fed’s taper talk itself, presumably, is an indicator that the Fed thinks the economy is improving. It sounds like you’re saying the markets are agreeing with the Fed’s assessment. I wonder what it would look like if markets didn’t share the Fed’s view.

    Recursion is a bitch.

  38. Gravatar of Matt McOsker Matt McOsker
    19. September 2013 at 05:10

    Inflation declining and GDP declining (though GDP had a recent boost becuase of methodology chage).

    http://research.stlouisfed.org/fred2/graph/#

    Mark, it is an asset swap bonds for reserves. Now the seller of the bond might use their reserves to buy stocks from somone else. But, in the end you have added ZERO net financial assets to the economy and net private savings remains unchanged with little credit expansion.

  39. Gravatar of ssumner ssumner
    19. September 2013 at 06:07

    kebko, I’m reluctant to say the liquidity effect refutes the EMH unless someone can show me some investment opportunities from this hypothesis. On the other hand I can’t explain why the liquidity affect impacts rates so far forward.

    Near the zero bound the slope of the yield curve is less informative about growth prospects than otherwise. And changes in the yield curve due to the liquidity effect near the zero bound are especially misleading. If there were no zero bound, short rates would have fallen by more than long rates yesterday.

    dtoh, Yup.

    James, I’m just as confused as you are.

    Brian, See my new post on interest rates.

  40. Gravatar of Mike Clayton Mike Clayton
    19. September 2013 at 16:38

    Fuzzy models always look bad when looking at hour to hour or day to day behaviors. Whenever human behavior is involved, things are not only fuzzy, but biased by belief systems which are stronger than logic. Perhaps we are only seeing a little logic overcoming some of those belief systems…hopefully.

  41. Gravatar of Interesting Tweets 09/20/2013 « ZEV Capital Research Blog Interesting Tweets 09/20/2013 « ZEV Capital Research Blog
    19. September 2013 at 16:41

    [...] 10TheMoneyIllusion1 1 1 32 » Instant reaction: All hail Ben Bernanke!34 [...]

  42. Gravatar of Potpourri Potpourri
    20. September 2013 at 09:41

    [...] Scott Sumner reasons from a price change and hails Ben Bernanke. (I’ll come back to this later, as Scott specifically mentions me in [...]

  43. Gravatar of Geoff Geoff
    22. September 2013 at 08:13

    Scott: “I won’t stop drinking, because every time I do, I get a headache. I am simply ‘making decisions based on data.’”

    What Bernanke did with this announcement is expose to the world just how messed up the economy is in the Fed’s opinion. It is so messed up, that the Fed believes it cannot reduce or stop $85 billion a month in debt monetization. This monetization will have to keep increasing if the Fed wants to prevent corrections.

    This announcement is yet another strong piece of evidence that the economy is in another bubble.

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