Fed Easing Isn't as Crazy as It Sounds
After putting the financial markets on high alert, central bankers have eased off their hawkish rhetoric to such an extent that some investors have begun to wonder whether the next major move might be an easing.
Although it’s barely discernible, CME futures have priced in a 2 percent probability that the Federal Reserve will cut rates. In a sure sign that uncertainty has risen, the European Central Bank announced last week that its president, Mario Draghi, would not use the Jackson Hole gathering this week to unveil plans for the tapering of the central bank's balance sheet growth.
The Draghi news coincided with the release of a paper urging central bankers to prepare to implement negative interest rates. It was written by Kenneth Rogoff of Harvard, a proponent of an eventual move to a cashless society.
“It is time for economists to stop pretending that implementing effective negative rates is as difficult today as it seemed in Keynes’ time,” Rogoff wrote. “The growth of electronic payment systems and the increasing marginalization of cash in legal transactions creates a much smoother path to negative rate policy today than even two decades ago.”
How has the discussion shifted so quickly from exiting unconventional monetary policy to committing further to it?
Every day of turmoil in Washington erodes the chances for passage of legislation that can prevent the onset of recession. The world and policy makers at the Fed have recognized as much.
If the Fed’s tightening campaign has come to a premature end, policy makers will be hamstrung when the time comes to begin the next easing campaign; “normal” launchpad levels more closely resemble a 4-percent federal funds rate versus today’s 1.25-percent starting point.
This raises the “what’s next” factor. Part of the stock market’s resilience comes down to the assumption that the Fed won’t pause if equities truly correct, falling 10 percent from their near-record highs. Defcon 1 will magically trigger Quantitative Easing 4.
The sticking point is the Fed’s own staff papers that question the validity of investors’ bravado; QE might have kindled animal spirits, but it did precious little to stimulate economic growth.
As for the requisite votes on the Federal Open Market Committee, hawks have pinned their hopes to the potential newest member of the panel, Randal Quarles, who is expected to be confirmed by the Senate in the coming months. Quarles once characterized Fed policy makers’ resistance to a rules-based disciplined approach to monetary policy making as “a crazy way to run a railroad.”
The other potential nominee would, if anything, ease the passage to a negative interest rate policy in the face of inefficacious QE. At last year’s Jackson Hole gathering, Marvin Goodfriend, a former Fed staffer and now an academic, said the zero-interest-rate bound was an “encumbrance.” Echoing Rogoff, Goodfriend proposed allowing the value of cash in circulation, as opposed to that deposited in a bank, to float. Yes, the absolute buying power of that $100 bill in your wallet would vary.
As for those naïve souls inclined to take issue with such intrusions? Goodfriend acknowledged that negative interest rate policy would have to be sold, but that “it should be possible to persuade the public,” for the greater good, that is.
Odds are Fed Chair Janet Yellen would side with Goodfriend. In February 2010 she said, “If it were possible to take interest rates into negative territory, I would be voting for that.”
With public support rising for Yellen to refuse reappointment as chair, the biggest open question remains the future composition of the FOMC. Who will be there to vote for the next major move when the time comes?
Bear in mind, the current economic expansion dates to June 2009. Moreover, the longest expansion on record ended in March 2001, exactly 10 years after it began. The current projections among those on the FOMC thus presuppose that this expansion will be the second-longest on record.
For the time being, the debate continues to revolve around the terminal size of the Fed’s balance sheet once it’s right-sized at the proposed glacial pace, several billion dollars at a clip. Given the shifting political and economic winds, this mental exercise is no doubt engaging, but also progressively futile.
Perhaps the only certainty that remains when it comes to predicting Fed policy is that there will always be the “out” of the data flow, which is increasingly suggestive of a cycle gasping for its last breath.
The truth is, unless the new administration is capable of engineering an economic miracle, and fast, we market watchers and investors are wasting time and energy debating tightening when easing could just as likely be the next move.
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