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Tuesday, June 05, 2012

Fed Watch: More Cold Water

One more from Tim Duy:

More Cold Water, by Tim Duy: This is an extension of my last post. I see St. Louis Federal Reserve President James Bullard also spoke today, and downplayed the employment report:

The recent nonfarm payrolls report was disappointing, but not enough to substantially alter the contours of the U.S. outlook.

He suggested seasonal distortions are at work - although, if they are at work, it means that the gains we saw earlier were outsized. In other words, once again, expectations for high growth were excessive - which should suggest to Bullard that his earlier concerns that tightening would occur sooner than 2014 were misplaced. He later makes this interesting comment after reviewing the path of Treasury yields:

One possible FOMC strategy is to simply pocket the lower yields and continue to wait-and-see on the U.S. economic outlook.

He doesn't really appreciate the negative signal currently sent by global interest rates. I don't think the US needs lower rates at the moment, what it needs is policy that actually induces higher rates in response to an improving economic environment. I imagine that, since Bullard believes the economy is operating at potential output, he might think lower rates are helpful as they would be consistent with easing some resource constraint, but I interpret the lower rates as evidence of being well below potential output.

Moreover, Bullard continues to believe that monetary policy is easy:

Current policy is already very easy, as the policy rate remains near zero and the balance sheet remains large.

If policy was easy, market participants would expect the Fed to raise interest rates sooner, and thus longer term yields would rise. If anything, the fall in rates implies that the Fed will need to keep interest rates low for a longer period. Policy is not easy.

Bullard also dismisses financial market distress as an artifact of the European crisis:

The global problems are clearly being driven by continued turmoil in Europe.

China might be a bigger driver than we realize, but I digress. Given that this is a European problem, the Fed is helpless:

A change in U.S. monetary policy at this juncture will not alter the situation in Europe.

This is one of those things that makes you shake your head in the wonder of it all. The point of further easing would not be to alter the situation in Europe - THE POINT IS TO PREVENT THE SITUATION IN EUROPE FROM WASHING UP ON US SHORES. You know, offer a counterweight to softer demand Moreover, if easier policy induces a weaker Dollar which then in turn prompts easier policy at the ECB (one can can dream), then the Fed is in fact altering the situation in Europe. So US monetary policy might, just might, have an important role even if the proximate cause of the distress is in Europe.

Bottom Line: Bullard downplayed the employment report adn doesn't sound like he wants additional easing. Like the stance of his colleague Dallas Federal Reserve President Richard Fisher, not a surprise. This kinds of comments keep me on edge that the pace of policy change will be slower than market participants believe. But again, this is an issue of how far the regional bank presidents are behind the policy curve. They could be close, they could be far. We will get a better idea in the back half of this week.

    Posted by on Tuesday, June 5, 2012 at 03:24 PM in Economics, Fed Watch, Monetary Policy | Permalink  Comments (7)


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