The Rise and Rise of the Bubble Managers

By David Llewellyn-Smith, founding publisher and former editor-in-chief of The Diplomat magazine, now the Asia Pacific’s leading geo-politics website. Originally posted at MacroBusiness

Barclays on the Fed:

Although we had expected a interest rate hike at this meeting, the non-hike was very close call. The language in the statement suggests that the committee was quite undecided in its view. More clearly, with three members dissenting against the decision and three, presumably different, members calling for no further rate hikes this year, the committee is more split than it has been at any time in our memory.

This split in views will make FOMC communication and action increasingly difficult this year. In particular, we believe that this level of dissent will make it difficult for the committee to keep the possibility of December rate hike live in the minds of market participants and, indeed, households and businesses.

Versus BofAML on the Fed:

The FOMC clearly signaled a hike before the end of the year in both the language and the dots

The Fed made two important changes to the statement:

1. the committee noted that near-term risks to the economic outlook “appear roughly balanced”. This is an important step for the Fed to justify hiking rates at an upcoming meeting and is a page out of the playbook from last year.

And, 2. “the Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of further progress toward its objectives.” This is a strong signal that the Fed is planning to hike in an upcoming meeting. It is not explicit calendar guidance, but it is a small step in that direction.

My own view is the Fed’s window is closed as oil falls, Chinese growth eases, Trump wins and Italy is shaken by the rise of MS5.

But that underlines the only point that matters these days. None of these events should be economically significant enough to derail a tightening cycle. What each can do is hammer sentiment and deflate asset markets. That’s why monetary policy observation has become a bit of a joke. You can line up as much data as you like but what the bubble manager feels about risk is now the key determinant in setting the cash rate.

The new reaction function of central banks is not inflation, nor unemployment, nor nominal GDP. It is what s/he had for breakfast, whether s/he got laid last night or whether s/he is dropping prozac.

Another example today is Captain Phil, Australia’s new RBA governor appearing on Capital Hill:

Our economy continues its transition following the boom in commodity prices and mining investment. According to the latest national account, GDP increased by 3.3 per cent over the year to June. This was a better outcome than was widely expected a year ago. It is also a little above most estimates of trend growth in our economy. Partly reflecting this above-trend growth, the unemployment rate has declined by around ½ percentage point over the past year. Again, this is a better outcome than was thought likely a year ago.

As is always the case, these aggregate outcomes mask significant variation across industries and regions. Those parts of the economy that benefited most from the resources boom are now experiencing difficult conditions, while other areas are doing considerably better. In these other areas, business conditions have improved, employment has increased and there are some signs of a modest pick-up in private investment.

Overall, the economy is adjusting reasonably well to the unwinding of the biggest mining investment boom in more than a century. This is a significant achievement. We are managing this adjustment partly because of the flexibility of the exchange rate and the flexibility of wages and through the support provided by monetary policy.

The story on income growth has been less positive, with growth in nominal GDP being disappointing. Over the past five years, nominal GDP has increased at an average rate of around 3 per cent per year. To put this number in context, between 2000 and 2007, nominal GDP grew at an average rate of 7½ per cent per year. This is quite a change. It goes some way to explaining the sense of disappointment in parts of the community about recent economic outcomes.

The main reason for the weak income growth over recent times is the large fall in the prices received for our exports. Since the September quarter 2011, export prices have fallen by around one-third. This fall, though, does need to be kept in perspective. Export prices remain considerably higher than they were in the 1990s and early 2000s, relative to the price of our imports. And of course, some of the fall in prices is because of increased production from Australia. So while we are receiving lower prices for our exports, we are selling more.

The recent news on commodity prices has been a bit more positive than it has been for a while. Over the past couple of months, the prices of some of our key exports have risen, partly in response to production cutbacks by high-cost producers elsewhere in the world. While it is difficult to predict the future, if these increases were to be sustained then we could look forward to the drag on national income from falling commodity prices coming to an end.

A second factor that has weighed on growth in nominal GDP is the slow rate of wage increases. This is a common experience across most industrialised countries at present, even those with strong employment growth. In Australia, the current rate of wage growth is the slowest in around two decades. It is part of the adjustment following the resources boom. Importantly, it means that many more people have jobs than would otherwise have been the case.

The low wage growth and lower commodity prices have meant that CPI inflation has been quite low over recent times. Inflation has also been held down by increased competition in parts of retailing and cost reductions in some supply chains. Slow growth in rents has also played a role.

The low inflation outcomes have provided scope for monetary policy to provide additional support to demand. The Reserve Bank Board decided to reduce the cash rate by 25 basis points in May and again in August this year. Lending rates have come down as a result. Deposit rates have, of course, also come down. The Board is very conscious that this means lower interest income for savers. Overall though, our judgement is that this easing in monetary policy is supporting jobs and economic activity in Australia, and thus improving the prospects for sustainable growth and inflation outcomes consistent with the medium-term target.

Looking forward, we expect the economy to continue to be supported by low interest rates and the depreciation of the exchange rate since early 2013. Importantly, the drag from the fall in mining investment will also come to an end. While mining investment still has some way to fall, our estimate is that around three-quarters of the total decline is now behind us.

Inflation is expected to remain low for some time, but then to gradually pick up as labour market conditions strengthen further.

One issue that has attracted a lot of attention of late is the housing market. The construction cycle has a bit more momentum than we expected earlier. This is adding to the supply of housing in the country, which partly explains the slow growth in rents. The rate at which established housing prices are increasing has also moderated, although there remain some pockets where prices are increasing briskly. Credit growth and turnover in the housing market are also lower than they were a year ago. Under APRA’s guidance, lending standards have also been tightened. Overall, then, the situation is somewhat more comfortable than it was a year ago, although we continue to watch things carefully.

Blather and blah. Captain Phil will cut again the moment he feels that housing is quiet enough that he can drive the currency lower to address weak inflation and income.

Monetary policy has become nothing more than a market soap opera.

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  1. Paula

    Smiled to see your “blather and blah”. After I immediately lost patience, scrolled down and thought, “I can’t read this stuff anymore.”

    1. abynormal

      B&B, me too. for the last 2 mos. a fed has spoken/snarked on avg every 3 days…make my tummy hurt.

      “It sometimes requires ignorance and arrogance to know something for sure.” …dat we be toasted!
      Mokokoma Mokhonoana

      1. Whine Country

        “The trouble with the world is that the stupid are cocksure, and the intelligent are full of doubt.” — Bertrand Russell

  2. Jim Haygood

    This post by Tad Rivelle of the eminent Los Angeles fixed income shop TCW (formerly Trust Company of the West), I would nominate as Commentary of the Year:

    While every asset price cycle is different, they all end the same way: in tears.

    Consider the chart below which plots the trajectory of cumulative asset prices (stocks, bonds, real-estate) against that of aggregate income (GDP).

    The chart reveals something rather extraordinary: over the course of the past 25 years, the traditional business cycle has been replaced with an asset price cycle.

    This results in all sorts of distortions that serve to further impair efficiency. Fortune 500 companies get to borrow cheap so as to repurchase shares even as small businesses are starved for capital; affluent homeowners get favorable access to loans to build swimming pools while renters suffer impoverishment by the resulting housing price inflation.

    Leverage goes up faster than the income available to service it. As such, the credit-fuelled expansion inevitably comes to a bad end.

    While the penultimate paragraph above strikes a decidedly populist note, the final one is positively Michael Hudsonesque.

    As Sally Snyder just said, abolish the freaking Fed. Give copies of the The Creature From Jekyll Island to those you love.

    1. Jim Haygood

      Here’s the faux aristocratic “royal we” version from the eminent Dennis Gartman:

      “We are, it seems to us, entering the period we shall call the “Zimbabwe-isation” of the global capital markets and we say that with all sincerity … and requisite trepidation.

      This will end badly of course. These things always do, but until they end … until the music finally stops … the game has to be played and the music, as it plays, has to be enjoyed.”

      When the music’s over, turn out the lights” — The Doors

  3. KPL

    “Monetary policy has become nothing more than a market soap opera.”

    Oh yes. Yesterday’s tango of Kuroda and Yellen was a treat to watch. It is printing and not earnings which matter now. The central bankers are running about like headless chickens trying to escape from the mess they have created. When will they be held accountable?

  4. MikeNY

    Ed Harrison called it right years ago when coined the phrase “the asset economy”. That’s all they know anymore. Think of the ocean of ink spilled since 2009 on Will they, or won’t they?, and what have we gotten? 25 bps. It’s like a Samuel Beckett play: so much talk, and nothing happens.

    I don’t see ‘regime change’ coming until something forces it: that is, forces a change in the paralysis and obstructionist culture in DC, and forces a redistribution of wealth — downward, for a change.

    1. Jim Haygood

      Both the Nasdaq Composite and Nasdaq 100 indexes set record highs yesterday, and are eclipsing them today.

      Thanks, J-yel!

          1. MikeNY

            The poor, beleaguered man will probably be right some day. Sadly, anyone who followed his advice will probably have nothing left to invest. ;-)

  5. Chauncey Gardiner

    Difficult to know which constituencies (individuals) really have the leverage here, could be acting together, and are playing 2008 Moneyball:

    – Fed and other central banks? (“‘Monetarism is dead, long live monetarism'” because the USG needs to increase domestic fiscal spending but is not doing so. So we need to buy up trillions of dollars of financial assets and suppress interest rates because, well… TINA.”)

    – “TBTF” Primary Dealers & their fellow travelers? (Benefit from perpetual ZIRP “free money”. Think derivatives and HFT leverage.)

    – USG agencies? (Infested with complacent neoliberal placeholders who perceive their self-interest to be embedded in perpetuating the status quo and are looking for their next gigs; or maybe I should say “GAGS”; i.e., Gig After Government Service.)

    – Deca-billionaire plutocrats seeking an alternative “asset-based” monetary system as the veins of private-sector debt are played out for now?

    Dang if I know the answer(s). Maybe this is just a reflection of cognitive bias and everyone is really acting in good faith. But there was an interesting (hypothetical?) ransom note to the Fed from “Wall Street” in a post yesterday (Sept 21) at Wall Street on Parade that caused me to re-think who might be walking in the shadows:

  6. JEHR

    Want more “blather and blah”: Here it is from our Governor of the Bank of Canada–

    Lower-for-longer interest rates require adjustments, Governor Poloz says
    Media Relations
    Québec, Québec
    20 September 2016
    Available as: PDF

    Canadians need to understand the forces that have led to a prolonged period of low interest rates and make adjustments, Bank of Canada Governor Stephen S. Poloz said.

    In a speech to the Association des économistes québécois, the Cercle finance du Québec and CFA Québec, Governor Poloz talked about the need for companies and households to adjust to the reality of interest rates that are likely to remain at low levels for a long time. Factors that restrain an economy’s speed limit—particularly aging workforces—are driving down interest rates in many countries.

    Lower-for-longer interest rates have made it more difficult for Canadians to finance their retirement through savings, the Governor noted. People are “rightly worried about their ability to live off their savings,” he said. “I certainly can sympathize and understand these concerns.” Longer life expectancy is compounding the challenge because people need to finance a longer retirement period, he added.

    Companies also need to adjust to lower interest rates by reducing expectations about future investment returns, the Governor stated. Investment spending has been weaker than expected, and Governor Poloz said one reason may be that some businesses aren’t taking into account the low-interest-rate environment when deciding if an investment will be worthwhile.

    If companies are waiting for returns near the levels that prevailed before the crisis, “they are unlikely to invest any time soon, and we will not see the kind of growth, productivity and job creation we are looking for,” Governor Poloz said. “And neither will the companies.”

    While there’s little that policy-makers can do about forces such as demographics, much can be done to help offset their impact on interest rates, the Governor noted. This means ensuring that policies in areas such as tax and immigration aren’t obstacles to business growth, and that young companies access financing.

    Authorities must also explore every avenue that would boost the economy’s potential growth rate, he said, pointing to investments in productivity-enhancing infrastructure and agreements to liberalize trade, both inside and outside Canada, as steps that could make an important difference over the medium term.

    Because the potential growth rate of Canada’s economy has slowed, “we need to take every decimal point of potential growth more seriously than we have in the past,” Governor Poloz said. “In a lower-for-longer world, these are opportunities we simply cannot afford to miss.”
    Content Type(s): Press, Press Releases

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