Rising long term rates are usually a bullish indicator
Arnold Kling recently made the following claim:
I would add myself to the list of economists who have some ‘splainin’ to do. I am always willing to be counted among those who doubt the Fed’s power over interest rates, especially long-term real rates. By the way, Scott Sumner used to say that a rise in long-term interest rates could be a bullish indicator. Would he say that now? UPDATE: No.
The correlation between nominal interest rates and NGDP (or RGDP) growth is overwhelming positive. Nothing that happened this week contradicts that. Indeed nothing that happened this week contradicts what I’ve been saying for the past 4 1/2 years:
1. Never reason from a price change.
2. Interest rates are a lousy indicator of the stance of monetary policy, because they reflect both liquidity effects and longer term effects.
I’ve made these points dozens of times.
As far as “bullish indicator,” suppose you were allowed one quick look into a crystal ball, at the level of interest rates in 2016. You are told ahead of time that the yield on Treasuries will be either 2% or 5% in 2016. If you are Paul Krugman, and are rooting for a strong recovery, which is the number you hope to see?
I hope I don’t even need to answer that question. And nothing that has happened this week in any way changes the answer.
So what have we learned this week? To me this is one data point, indicating tight money is slightly more likely to raise long term rates than I had previously assumed. But there is still the enormous stock of previous long term rate changes in response to previous Fed moves. Previous data points. January 2001, September 2007, December 2007, etc. etc. Should we suddenly throw all those observations away?
PS. The fact that Krugman, Cowen, Kling, myself and many others were surprised by the surge in rates over the past few weeks actually speaks well of our understanding of macro. It shows that we’ve been paying attention, that rates don’t usually behave this way. As for those who “got it right,” you have some “splaining to do” about the surging yields in Japan in response to more QE.
The best solution is to remove interest rates from macro, and focus on the three variables that matter; NGDP, nominal wages, and hours worked.
PS. Unlike Kling, I think the central bank has enormous influence over long term rates, but mostly via the income and inflation effects.
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25. June 2013 at 05:23
Rates also correlate strongly with velocity. And, the 30 year 2 year yield curve spread has widened back above 300 bps. If higher expected future short rates were likely to weaken NGDP, the term structure should be flattening. So maybe theres a more bullish interpretation here…
25. June 2013 at 06:05
Again, another case of watching Mickey Mantle trying to hit Hoyt Wilhelm.
25. June 2013 at 06:14
Good News today:
“April Case-Shiller 12.1% vs 10.5% expectations and March at 10.9%. Fastest growth in 7 years. Gains seen in 19 out of 20 states.”
“Highest consumer confidence number since summer 2008”
25. June 2013 at 06:18
“New Home Sales at 476,000 SAAR in May http://goo.gl/fb/3JAKH “
25. June 2013 at 06:28
“The best solution is to remove interest rates from macro, and focus on the three variables that matter; NGDP, nominal wages, and hours worked.”
Might not interest rates be more than an inter-temporal price? Couldn’t they be a measure of expectations about future NGDP? And maybe capture uncertainty affecting the economy in other ways? Finally with all the factors that you care about measured with error (or at least hard to interpret at times) shouldn’t we try to extract signal from rates too. Maybe the wide-ranging focus is not a defect of macro, but a reality of noisy signals.
25. June 2013 at 06:52
I just went back to look at the 1994 and 2004 Fed exit episodes.
Both led to a relatively sustained rise in nominal bond yields. Stocks markets initially fell by about 9% in 1994 and 7% in 2004. And then in 1994 we had a six year bull market. In 2004, the rally that had begun in late 2002 continued until mid-2007.
So, if we assume the May 22nd FOMC meeting effectively launched the “exit” by verbal means, the recent stock market drop would fit the 1994 and 2004 patterns.
If it was just an abstract discussion of possible future scenarios, and the data as well the stock market (continue) to tank, then QE will simply continue as is, first verbally (which would also be considered as an effective reversal of the May 22nd tightening).
That is – if it all wasn’t just driven by cash-starved Chinese banks dumping Treasuries because they weren’t able to raise it from the local money market or the PBOC.
The real question for me is what the globally consistent out-performance of developed markets (G7) versus the emerging economies and BRICS tells us. G7 stock market strength has become evident late last year, with the advent of “Abenomics”.
It could be that markets are anticipating a G7 reflation success, and I’m not talking about the next few weeks or months, but years if not the entire decade.
This would be a tremendous success for Bernanke, who, even though he did improvise as he went along, he eventually moved the whole thing in the right direction, pushing the Japanese and at least mentally even the ECB (or at least Mario Draghi) in that direction.
For the time being, it’s just a hunch, but you never know.
25. June 2013 at 06:56
Scott,
You’re becoming slightly like the Fed, always saying recovery could happen in about two years. I remember back in 2009 when you said something like “which would you rather have in two years the Federal Funds rate at 0.25% or 3.25%? If it’s still 0.25% in 2011 I’d have a sinking feeling. We’ve become Japan.”
Good to see that hope springs eternal and you haven’t written this off as a repeat of Japan.
25. June 2013 at 07:39
Dr. Sumner,
You’re giving the Fed too much credit for the rising rates. With the finance headlines reading, ‘China tells regional banks, “You’re on your own,”‘ it’s easy to see why investors might think it’ll be the great depression all over again. Rates spiked like crazy in 2008 and that was with an active Fed propping everything up. Replace the Fed with a laissez-faire central banker and we’d all be living in Hoovervilles.
25. June 2013 at 07:56
It’s silly to want to take out interest rates — the Fed does have huge influence on interest rates thru … the mechanism of raising or lowering interest rates.
There’s no control mechanism for the Fed to use that directly affects hours, nor employment, nor even NGDP.
Monetary macro is about 1) what the central bank should do about interest rates, at the current time;
2) what the CB should do about base money. And/or QE/QT (not much Tightening yet).
3) other Fed actions.
It’s long been a weakness of the NGDP targeting idea that the Fed action to achieve higher NGDP is not clear. “Looser money” is not clear.
25. June 2013 at 08:30
So Stein and Fisher think Fed policy is creating bubbles in things like leveraged loans, junk bonds, and other high yield credit instruments.
Here’s the problem: the ideal environment for these instruments is no inflation and tepid growth, the very policy the Stein and Fisher advocate to ‘prick’ the bubbles.
Why is this? Well, no inflation means the real return on fixed income is quite good. And sustained modest growth is sufficient to keep default rates near historic lows.
I would suggest that we do not have a bubble to prick, but rather a bubble in pricks.
25. June 2013 at 08:59
Tom,
But the Fed does not set interest rates. The Fed engages in open market operations to influence interest rates. The Taylor Rule is not stable over time or across borders, so there is no set amount by which the Fed should lower the interest rate when unemployment is up by 2%. Interest rates are simply a signal of the effect of the Fed’s actions on NGDP. When the Fed lowers interest rates, they are raising NGDP.
With NGDP targeting, there is a question of how much the Fed needs to do to get NGDP on target. But, with interest rate targeting, there is equally a question of what the interest rate target should be given economic conditions. These questions are essentially the same in a non-ZLB environment.
The true target is NGDP. The interest rate is a signal that becomes particularly useless in a ZLB environment. It should not distract us from the actual purpose of Fed policy which is to hit a NGDP target.
25. June 2013 at 09:02
Tom,
Moreover, when the Fed announces a new interest rate target, they just buy or sell treasuries until they hit the target. With a NGDP prediction market, the exact same mechanism could target NGDP.
25. June 2013 at 10:00
“As for those who “got it right,” you have some “splaining to do” about the surging yields in Japan in response to more QE.”
They didn’t rise, they fell.
Later, they went back up, but you don’t believe in “long and variable lags”, right? So it’s the contemporaneous movement which counts.
Lots of conundrums lately.
25. June 2013 at 10:10
On May 31 Krugman did a simple chart analysis of the rise in long rates and concluded it meant “Stronger recovery”:
http://krugman.blogs.nytimes.com/2013/05/29/rate-stories/
The key thing was the dollar and the stock market were both up at that time.
But with the benefit of hindsight we see that the S&P 500 had peaked on May 21 and whereas it was only down 0.9% on May 30, it is now down over 5.8%. Thus Krugman’s nifty little chart analysis is now screaming “Tougher Fed”.
Even if China is a factor, China is not responsible for how the Fed reacts, or fails to react, to changing economic conditions. If monetary policy is getting rapidly tighter the Fed probably should do something now rather than wait until later.
P.S. This would be a lot simpler with an NGDP futures market.
P.P.S. Given David Glasner’s past observations on inflation expectations and the stock market I wonder what he will say when he gets around to it.
25. June 2013 at 10:10
–“So what have we learned this week? To me this is one data point, indicating tight money is slightly more likely to raise long term rates than I had previously assumed. But there is still the enormous stock of previous long term rate changes in response to previous Fed moves. Previous data points. January 2001, September 2007, December 2007, etc. etc. Should we suddenly throw all those observations away?”–
I don’t think you have to throw those observations away. I think rising long term rates despite tighter monetary policy is explainable even as a market monetarist.
I see you’re not convinced by my comments on another post, but what is it about them you object to?
Long term Treasury yields reflect expectations about the evolution of short term yields. Consider a bond market with with only two bonds – 1 year maturity and 2 year maturity. The yield on the 2 year maturity bond must contain important information on what the general expectations for 1 year yields 1 year forward. So if 1 year bonds are yielding 1% and 2 year bonds are yielding 1.5%, the market must be expecting 2% 1 year yields next year. If 3% 1 year yields were generally expected, then investors would sell 2 year bonds until the yield rose to 2%, because it would make more sense to own a 1 year bond now, earn the 1%, then reinvest a year from now at 3%.
Certainly other factors come into play, such as interest rate risk, inflation risk, preferred habitat, etc, but despite those other factors the expected path of short term yields must be an important driver of long term yields. I know you’re well aware of all this, but I just want to be clear why this makes sense to me.
The market monetarist result of lower long term yields occurring in conjunction with monetary policy tightening we typically observe is due to tighter money depressing the expected time path for short term rates. It does not necessarily follow that tight money will *always* depress the expected time path of short term rates.
25. June 2013 at 10:16
Max,
You wrote:
“They didn’t rise, they fell.”
Kuroda announced the specifics of the Japanese large scale asset purchase program on April 3. Ten year Japanese government bonds peaked the following day with the yield closing at just under 0.45%. In short, Japanese bond yields only started to rise after the BOJ actually started to buy them.
25. June 2013 at 10:42
The China-selling story is pure bunko — and those who pass it on are either incompetent or misdirecting.
Don’t ever think that you know something because you read it in the FT or WSJ. In fact, don’t believe something until it has been officially denied.
The rise in inflation-linked bond yields cuts across many countries — it is not a technical move in US bonds. There could be mechanisms for this global move — funding liquidity, commodity prices.
Upshifts in real yields & breakevens tends to hurt the bid for risk, period: nothing to do with NGDP. (Note to all, also: “stocks move higher” is not a good place to hang one’s monetary hat — tight money can also boost stock prices due to lower yields and higher P/E multiples.)
25. June 2013 at 14:43
[…] Now if Krugman is a bit slippery, Scott Sumner is jaw-dropping in his audacity. In response to Arnold Kling saying the past two weeks present a bit of a problem, Scott writes: […]
25. June 2013 at 17:49
Tommy, That’s possible,
Claudia, That’s why we really need a NGDP futures market.
Mikio, I hope you are right.
John, Those weren’t predictions, just hypotheticals. But yes, I do think a recovery is possible in two years, albeit unlikely.
Randomize, Rates spiked in 2008?
Tom, You said;
“It’s silly to want to take out interest rates “” the Fed does have huge influence on interest rates thru … the mechanism of raising or lowering interest rates.”
I always wondered how the Fed controlled rates.
Steve, It all goes back to easy money. They and most other economists (I’d guess 98%) think money is easy. And they are all wrong.
Max, Good point–so what caused the yields to soar in Japan?
Mark, Good points.
Justin, Agreed, but I’d expect it to depress expected rates 5 to 10 years out, wouldn’t you?
I’m not saying you are wrong–it obviously happened, but I do find it surprising.
26. June 2013 at 07:57
Dr. Sumner,
Right, I just compared apples to oranges. Treasuries dipped as people fled to them while corporate rates went crazy.
26. June 2013 at 18:46
Great points Mikio.
Scott, My sense and hope is that this is the fine edge of QE exit. If the (long term bond) market agrees with the Fed’s assessment, that growth is improving, and that the Fed is on it’s way to tightening, but still trying to be accommodative at least until the Evans Rule is fulfilled, then long term rates should rise. It would be vindication for the MM view. Give it time, as it will not likely happen overnight. Just as each QE was followed by higher rates, because of implied faster NGDP growth, so you would expect a rise in long term rates, if the end to QE and possible raising of the FF rate were presumed likely as a result of assumed faster NGDP growth. If you ask me, the Bernanke has been listening to you, and is hoping the market eventually gets his drift. Politics and structure don’t allow him to be quite as clear about his objectives, but it seems the long bond market has figured it out. And don’t distress about a drop in rates in the coming days. If he sticks to his guns, we’ll have higher rates, but as a result of a stronger economy.
26. June 2013 at 18:54
Just to be clear, each QE implied faster NGDP growth. The fine edge is when assumed faster NGDP growth implies the end of QE and a return to normalcy. Well done Bernanke, hope it works. I believe this has been referred to as the Chuck Norris effect.
27. June 2013 at 10:47
ds123, Thanks, but in my view it would be a disaster if this became viewed as “market monetarist policy.” We’ve had a Great Recession (in my view) precisely because the Fed didn’t follow the advice of the MMs.
28. June 2013 at 22:54
“The correlation between nominal interest rates and NGDP (or RGDP) growth is overwhelming positive. Nothing that happened this week contradicts that. Indeed nothing that happened this week contradicts what I’ve been saying for the past 4 1/2 years”
This is BS. You’ve stated to me personally that monetary inflation harms the initial receivers (bondholders) without qualification, which of course means the opposite of what just recently happened with Fed tightening and bond yields.
You gloated in your “Take that Cantillon effect fans” when yields fell after a stimulus announcement, also without qualification.
You once denied consumer price inflation, but then soon after claimed there was consumer price inflation and that you knew it all along.
You have been wrong so many times it is difficult to count them. For you to sit there and claim that nothing has happened that contradicts what you said, reveals just how out of touch you are with not only reality, but what you are saying as well. You’re clearly a demagogue who is so afraid of the other side being right, that he refuses to admit even once when he is wrong.
“We’ve had a Great Recession (in my view) precisely because the Fed didn’t follow the advice of the MMs.”
We’d have an even greater one if we did, since MM calls for even more inflation than orthodox monetarism as the “solution” during the outset of corrections to distorted capital structures, and hence calls for even fewer corrections to said structures in the short run, which of course leads to a worse set of inevitable corrections in the long run, which we are experiencing from past short run monetary “stimuli” with stagnating real wages over the long run. Thanks Nixon.