Bullard channels Lars Svensson

So I go to a monetary conference in Italy for a few days and everything falls apart. Actually that’s an exaggeration–if we think in terms of levels, the stock market is still doing fine.

In any case there’s an extraordinary amount of news, and I haven’t been able to keep up.  These are initial reactions:

1.  I have no idea why real T-bond yields are soaring—no idea at all.  However given the rise in real bond yields, the stock market setback is quite small, indicating that the market doesn’t expect significantly slower growth.  That also confuses me.

2.  I’ve been heavily criticized for claiming “monetary offset,” as Bernanke himself says the Fed can’t offset the negative effects of fiscal austerity.  Make that Bernanke used to say that; now he talks like a market monetarist:

Bernanke said the quantitative-easing program could end in the middle of next year. The chairman was upbeat about the outlook, saying housing was strong and the recovery seemed to be brushing aside any headwinds from fiscal policy.

3.  I’ve had issues with James Bullard in the past, as he seems to focus too much on short term movements in inflation, which are often transitory.  But given the current low level of inflation, and low 5 year TIPS spreads, I can’t disagree with this:

In a statement elaborating his dissent from the Fed policy decision issued Wednesday, Bullard noted that the central bank announced that less-accommodative policy was in store at the same time that it marked down its forecasts for 2013 growth and inflation.

. . .

Bullard, who is most often classified as a hawkish member of the Fed’s leadership team, dissented for dovish reasons: He thinks the Fed might have to ease more to get inflation higher.

Remove the word “more” and he’s exactly right.

In a separate interview with the Washington Post, Bullard said the Fed was more hawkish today than it was one week ago.

He attributed the volatility in financial markets not to Fed communication, but to perceptions of upcoming “tighter policy.” “You can communicate it one way or another way, but the markets are saying that they’re pulling up the probability we’re going to withdraw from the QE program sooner than they expected, and that’s having a big influence,” Bullard said.

The Fed would like inflation to average 2% over time. But the central bank’s favorite inflation target has fallen to 0.7% over the past 12 months.

Prior to this week’s Fed meeting, Bullard had raised a red flag about the inflation data, saying he thought the Fed might stand pat until it better understood the factors behind the trend. He stressed the issue in his dissent, saying the Fed “should have more strongly signaled its willingness to defend its inflation target of 2% in light of recent low inflation readings.”

The Fed “must defend its inflation target when inflation is below target as well as when it is above target,” the Friday statement said.

In more general terms, Bullard said he was concerned the Fed is making decisions based on calendar dates and not incoming economic data.

Bullard is saying that at the current policy setting we are likely to undershoot on inflation, and hence we should ease.  But Bernanke just tightened policy.  Bullard is just as frustrated as Svensson used to be at the Riksbank, and for exactly the same reason.

4.  And then I find out that Obama just fired Bernanke.

5.  And the Greeks are still causing market turmoil.

So year after year the markets, and market monetarists, are right, and the Fed is wrong.  How long before the Fed figures out that money’s been too tight since 2008?

PS.  I haven’t had a chance to look at the old comments, but will do so tonight and tomorrow.  I’ll be increasingly busy over the next year, and will have to cut back in some areas.  If you email me, don’t recommend I look at some paper.  Tell me why it’s interesting, including page numbers.  I’m going to have to learn to say no to many requests, as I’m overextended on many fronts.  But the blog will continue.

PPS. In the previous email I mentioned my frustration with my iPad.  In Italy I tried to answer emails, but every time I typed a word it automatically converted it into another word–perhaps Italian (some words I didn’t recognize.)  So I eventually gave up.



17 Responses to “Bullard channels Lars Svensson”

  1. Gravatar of Frank Frank
    21. June 2013 at 17:38

    Regarding the 10 Year Treasury sell off; might it be bond fund managers hurriedly shortening their fund duration before the end of 2Q 2013. I figure they can no longer sell 3rd world debt positions, and esoteric debt positions because liquidity dried up. So i suspect the 10 yr Treasury will rally soon, especially if we get disappointing economic news or a some new negative news in Euroland. The real yield is now compelling.

  2. Gravatar of Scott N Scott N
    21. June 2013 at 17:38

    The sharp rise in TIPS yields began on the first Friday in May when we broke a three year streak of really disappointing jobs reports. It gained steam on the first Friday in June when the jobs report suprised to the upside (again breaking a three year string of disappointing jobs reports on that date).

    I think the bond market is pricing in both stronger growth and a higher likelihood that the Fed will raise interest rates sooner rather than later. If I am right, then we are only one bad jobs report away from a sharp reversal in bond yields.

    Evan Soltas has concluded that yields are rising “because of a change in investor expectations of the monetary exit, independent of economic conditions” – i.e., the Fed is tightening. I’m not sure I agree with Evan and his analysis, but I can’t pinpoint the reason. Anyway, it is worth reading.

  3. Gravatar of marcus nunes marcus nunes
    21. June 2013 at 19:48

    And in Japan some at the BoJ feel that they are incapable of generating higher inflation!

  4. Gravatar of Benjamin Cole Benjamin Cole
    21. June 2013 at 20:52

    You know what is nuts?

    I mean, nuts-a-rama?

    Suppose you had “Plan X.” And “Plan X” would result in GDP real growth of 5 percent a year for five years, but also 5 percent inflation for those five years. For sake of argument, let us say “Plan X” would work as advertised.

    Of course, under Plan X it would be Fat City for workers, businesses and profits, and federal receipts would probably come to equal federal outlays.
    The national debt-to-GDP ratio would go into steep decline. The economy in general would deleverage.

    But what would the Fed say to “Plan X”?

    “Oh dear no. We can’t adopt Plan X. The inflation rate is too high!”

    Sad to say, the ECB and BoJ would say the same thing. In other words, for about one-half of the global economy, central bankers would not accept Plan X—even if they conceded it would work as advertised.

    This does not bode well.

    I suspect interest rates in one year will be where they are today, if not lower.

    Scott Sumner has it right: Interest rates have been trending down for decades, and hit zero in Japan long ago. What makes us think we will be different, if our Fed does not act differently?

  5. Gravatar of Riccardo Leggio Riccardo Leggio
    21. June 2013 at 22:22

    About iPad auto word correction as you type, don’t give up. It takes some getting use to because you have to watch the words being typed as they’re being typed, and when you see the wrong one being suggested – then you have to intervene, tapping the little x next to the suggestion to cancel it, letting you type the word you intend. I know this sounds cumbersome, and it is at first. But if you persist you actually train the iPad spell-checker so that pretty soon it stops suggesting 8th grade words where you’re intending something more sophisticated. Another advantage is that many of the auto-suggestions and corrections ARE helpful. For example, when I type “i” meaning I myself, it automatically capitalizes it for me (which IS the right guess 98% of time); and when I type a contraction without the apostrophe, it automatically adds it for me so I “don’t” have to. Typing actually gets faster over time once you get the hang of it.

  6. Gravatar of 123 123
    22. June 2013 at 01:10

    Go to Settings, General, Keyboard, Auto-Correction to switch the autocorrect off.

  7. Gravatar of Gary Gary
    22. June 2013 at 04:32

    To turn auto correct off on iPad:

    1. Navigate to Settings -> General -> Keyboard

    2. Touch Auto-Correction -> OFF

  8. Gravatar of ssumner ssumner
    22. June 2013 at 05:53

    Riccardo, Thanks, but why does it consistently autocorrect into foreign words I’ve never heard of? And it does so virtually every word. Back in the US, this no longer happens.

    Everyone: Regarding interest rates, I’ll just repeat my answer from the previous post:

    Some claim that rising bond yields reflect increased expectations of economic growth. The problem with that view is that rates spiked after the Fed (and later Bernanke) issued statements that were more contractionary than expected. I don’t think there is any model that predicts more contractionary than expected monetary policy will lead to higher nominal growth.

    A slightly better argument is that the spike in long term yields reflects the liquidity effect, but as “dlr” points out yields rose for very long term bonds. I’ve seen this puzzle before; at times contractionary monetary news makes long yields fall, and at other times it makes long yields rise. And I still have no explanation.

    Another possibility is that markets think the Fed has better data on long term growth prospects than they do, but in that case I’m surprised that stocks fell so sharply. And I doubt the Fed does have better data, they’ve done worse at predicting the economy than the private consensus.

  9. Gravatar of MikeDC MikeDC
    22. June 2013 at 06:03

    The Logitech Ultrathin Keyboard for the iPad would maybe help you. I’ve got the older version, and while it’s not quite as easy as a full scale keyboard, it’s worlds easier than the on-screen keyboard and makes it feasible.

  10. Gravatar of Common Sense vs. Scott Sumner Common Sense vs. Scott Sumner
    22. June 2013 at 07:07

    […] happened in Japan recently, I think they had the decency to admit it puzzled them. And to be fair, Scott has the decency right now to write: “I have no idea why real T-bond yields are soaring””no idea at all. […]

  11. Gravatar of Daniel J Daniel J
    22. June 2013 at 07:34

    Something tells me that the spike in yields in Japan spooked them. Now Jeremy Stein and Esther George are yelling, “See!? See!?”

  12. Gravatar of dlr dlr
    22. June 2013 at 08:01

    Scott, I admire that you acknowledge that this has been a real conundrum. So many other sharp monetary thinkers have gone with facile rationalizations, such as arguing that the long term economic outlook improved with the fed’s new outlook (I find this one laughable but many smart people have gone with it), or ignored it altogether. But does the ferocity of this quandary (meaning the really big move in long term real rates we’ve seen amid a seemingly contractionary policy change) have any affect on some of your underlying priors? Specifically, have you had any second thoughts about the relative import of the Fed’s ability to directly manipulate the real curve outside of both the Fisher Effect and the Liquidity Effect and/or the degree of noise that might frustrate the use of market bond prices to understand what is going with underlying expectations about real, required, low risk returns on marginal investment? I am not talking about you disowning EMH here. Just whether incidents like this are enough to make you rethink whether short term market reactions are quite as informative about policy effectiveness as you sometimes argue they are.

    Also, why not just turn off autocorrect altogether on your ipad under settings (and/or make sure that you are not set to an international keyboard)?

  13. Gravatar of guest guest
    22. June 2013 at 11:21

    dlr, actually when you think about it, reliance on the EMH (or an especially strong version thereof) is an actual weak point for Scott’s preferred theory. Basically, once you accept that the EMH may not hold in an especially strong sense, it becomes plausible that assets prices may be influenced by monetary policy in unclear ways – for instance, interest rate moves may directly affect portfolio choices by banks and thus move assets prices. This means that the assumption that moves in the markets reflect changed expectations about economic output may be rather more fragile than is generally assumed.

    Interestingly, many ‘finance’ types seem to hold a similar view of how monetary policy impacts assets prices, and this may explain why they tend to be especially skeptical about MM.

  14. Gravatar of dlr dlr
    22. June 2013 at 11:42

    guest, as a finance type who is largely inclined toward MM, I agree. I think the overwhelming evidence you are accosted with if you are a fund manager of all kinds of incomplete markets is a tempting detour down the the road toward frictional myopia. I think this happens to academics, too, and it leads to all sorts of worthwhile but ultimately excessive crevice seeking, aka new monetarism. But it’s also a detour down a different road which departs from the forest altogether, which becomes some caricatured version of “Bad” Kocherlakota (Kocherlakota is like the Manu Ginobili of monetary theory, sometimes he is beyond brilliant and sometimes you think he is playing a joke on you), where low interest rate are exogenously chosen by the Fed over every time frame and independent of equilibrating mechanisms, and act primarily to boost asset prices while delaying some kind of liquidationist and deleveraging comeuppance (that is the very prevalent caricture, not “bad” Kocherlakota).

    I think Scott cheats very slightly by resorting to a fairly weak definition of EMH but then sometimes cherry picking theory-friendly market reactions as compelling evidence of the effectiveness of (or proof of the transmission mechanism for) lag-less monetary policy, as if appealing to a stronger definition. I think it a very benign kind of cheating, but one that would be a particular and visceral turn off to a prototypical HF manager considering conversion to the dark side.

  15. Gravatar of ssumner ssumner
    22. June 2013 at 13:09

    MikeDC, Thanks.

    Daniel, Stein WANTS yields to “spike.” In any case, the rise in Japanese yields was very small.

    dlr, Those are good points. However I do have similar observations in a number of previous posts. I’ve occasionally pointed out that interest rate moves can be puzzling, but I can see why you think I “cheat” a bit, as I do tend to emphasize the moves that fit my theory best. Perhaps the following will help:

    1. To some extent I’m pushing back against conventional wisdom. Thus almost everyone assumes low rates mean easy money, and vice versa. I like to present contrarian examples, but I usually word them carefully, to indicate that easy money often raises rates. One claim I will stand by is that highly easy money, easy enough to be expected to create a nominal boom, is very likely to raise rates.

    2. I’m reluctant to abandon the EMH based on a few examples that seem puzzling. If I really believed the EMH was false, I should switch professions, and start trading bond derivatives. I’d be buying 30 year bonds right now.

  16. Gravatar of Ricardo Ricardo
    22. June 2013 at 17:38

    I admit to being absolutely shocked at the rapid increase in real rates in the past month or two, especially so after the taper talk.
    Also, very surprised in just strictly nominal terms. Never thought the ust10y would slice thru 2.4 like butter.

    I doubted it, but the NY Fed has said they estimated they were artificially suppressing nominal treasury yields 50-100 basis points (not sure what part of the curve they were referring to).

    When I’m fundamentally puzzled, I fall back on technicals:
    – Mean-reversion generally works if a market seems way out-of-kilter very short term (<1 month) or longer term (2-5 yrs).
    – Momentum generally carries in between those time frames.

    So, if the yields on the long end dont show much sign of coming down in the next few weeks, I'd get short long-term debt.

    Also, when I'm puzzled by a strong market move and *first think* "this can't continue, market will mean-revert soon", it generally does not in the medium term.

  17. Gravatar of ssumner ssumner
    23. June 2013 at 06:18

    Ricardo, I was surprised as well.

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