Bernanke Beating Draghi Prowess on Signaling

Federal Reserve Chairman Ben S. Bernanke is proving more successful than his European counterparts in steering how investors view interest rates.

In a Jan. 14 analysis of so-called forward guidance, Gustavo Reis of Bank of America Corp. studied how successfully policy makers have been by signaling their plans to keep interest rates low. The strategy is based on the idea that investors will then restrain the borrowing costs set by markets, in turn helping households and companies.

Inspired by a suggestion from Bank of England Deputy Governor Charles Bean, Reis looked at how much markets expect it will cost to borrow dollars for a year in two years’ time. He then tested the so-called forward rate’s sensitivity to data that beats the forecasts of economists. If investors trust the words of central banks, they will limit their response in those circumstances, the theory goes.

In the case of the U.S., Reis found the Fed was able to damp the reaction of markets to strong data in 2011, the year the central bank began saying it would keep interest rates low over specific calendar periods. The Fed also succeeded in limiting rate expectations when it said last month it would keep its benchmark rate near zero “well past the time” when joblessness falls below 6.5 percent.

The pattern is less clear in Europe. European Central Bank President Mario Draghi said last July that rates would stay low for an “extended period.” Bank of England Governor Mark Carney has used similar language since he arrived last July. In August he said he and his colleagues won’t discuss increasing rates before unemployment drops to 7 percent. The response of markets to such statements “seems tentative,” said Reis.

More positive are economists led by Peter Hooper at Deutsche Bank AG in New York. They said in a Jan. 13 report that globally, the forward guidance “experience has so far been largely successful, judging by the reaction of market rates.”

The problem now is that some of the policy’s limits may be nearing as the Fed and the BOE come close to hitting their unemployment thresholds of 6.5 percent and 7 percent respectively. “This forces central banks to make ongoing adjustments in their guidance, posing rising risks to credibility and the capacity to effectively steer market valuations,” the Deutsche economists said.

The challenge for the Fed is underscored by a chart from Torsten Slok, another Deutsche economist. It showed the Fed’s policy statements are now nearing 900 words in length, compared to about 300 words before the financial crisis.

“It is more and more difficult for the Fed to explain what they are doing,” said Slok.

* * *

The U.S.’s shale boom is only at the halfway mark, according to a UBS AG evaluation of government data that leaves it optimistic about the value of the dollar.

The U.S. Energy Information Administration’s 2014 outlook predicts domestic crude oil production will keep rising through 2016 and only decline from its peak from 2019.

That suggests daily output will increase to almost 15 million barrels a day by 2016 from around 8 million barrels a day in 2008 and 12 million barrels a day last year.

“Thus America’s shale energy boom that began at the start of the decade appears only halfway to reaching its peak,” said Mansoor Mohi-uddin, UBS’s chief currency strategist in Singapore, in a report published Jan. 11. He said the dollar will be supported over the next three years.

* * *

Global stock markets are not in bubble territory yet, giving central bankers an excuse to keep monetary policy loose.

So say strategists at Barclays Plc, who estimate the current price to earnings ratio of 17.1 is “bang in line” with the 17.5 average since 1970. The price to book relationship of

2.1 is also the same since 1974.

“These valuations should in no way raise alarm in policy making circles,” analysts Ian Scott, Dennis Jose and Joao Toniato wrote in a Jan. 13 report.

That’s because global economic growth remains below potential and earnings per share will probably rise 11 percent this year, they said.

* * *

The U.S. is safe from deflationary forces even as inflation undershoots central bank targets in most industrial economies.

A Jan. 10 report by Goldman Sachs Group Inc. economist David Mericle came to that conclusion even though inflation is below policy maker goals in 16 of 19 major economies.

That shouldn’t be surprising, given that slack remains in most economies, weighing on wages and prices, said Mericle. Commodity prices have also proven soft lately.

The question he asks is whether globalization has “fundamentally changed the inflation process into one governed primarily by global rather than domestic forces?”

While economists at the Bank for International Settlements in Basel, Switzerland, have suggested that may be the case, Mericle thinks not in the case of key rich nations. He looked at the difference between the world economy’s growth and its potential and applied that so-called output gap to U.S. measures of inflation. He also created a common inflation factor by looking at prices outside of energy and food since 1997.

Even with inflation slowing across the world and prices falling in countries such as Greece, the results showed little effect on the U.S. The same stood for most countries, including the U.K., Germany and Australia.

Economies that are affected more by foreign inflation tend to be those more open to trade or where inflation has become less anchored, such as Slovakia and Hungary, he said.

* * *

The gap in economic growth between the U.S. and Japan is mostly explained by a divergence in the number of hours worked in each nation, said economists at the Federal Reserve Bank of St. Louis.

Japan grew by an annual average of 0.7 percent between 1991 and 2011, while the U.S. expanded 2.6 percent, they said in a report published last month.

The explanation for the difference, given by Juan M. Sanchez and Emircan Yurdagul, is that total hours worked in Japan grew an average 0.5 percent each year from 1971 to 1991 before shrinking 1 percent over the next two decades. The U.S. rates were 1.6 percent and 0.8 percent over the same timeframes.

One reason for the gap: U.S. population growth outpaced that of Japan, said Sanchez and Yurdagul.

* * *

Bountiful natural resources mean countries often collect fewer taxes from other corners of their economies.

In a working paper published this week, International Monetary Fund economists Ernesto Crivelli and Sanjeev Gupta constructed a database for 35 resource-rich countries.

They found for each additional percentage point in resource revenue the government collects, there is a corresponding reduction in domestic or non-resource receipts of about 0.3 point of gross domestic product.

Such imbalances could be a source of concern because they leave nations more dependent on volatile resource revenues, Crivelli and Gupta said.

(Sign up to receive Cutting Research stories: SALT CUTTING)
    Before it's here, it's on the Bloomberg Terminal. LEARN MORE