fed

The Fed Resumes Buying Treasuries: Is This the Start of, Ahem, QE?

Scott BuchananLeave a comment

In some quarters there is a sense that quantitative easing (QE), the massive purchase of Treasury and other bonds by the Fed, is something embarrassing or disreputable – – an admission of failure, or an enabling of profligate financial behaviors. For months, pundits have been smacking their lips in anticipation of QE-like Fed actions, so they could say, “I told you so”. In particular, folks have predicted that the Fed would try to disguise the QE-ness of their action by giving some other, more innocuous name.

Here is how liquidity analyst Michael Howell humorously put it on Dec 7:

All leave has been cancelled in the Fed’s Acronym Department. They are hurriedly working over-time, desperately trying to think up an anodyne name to dub (inevitable) future liquidity interventions in time for the upcoming FOMC meeting. They plainly cannot use the politically-charged ‘QE’. We favor the term ‘Not-QE, QE’, but odds are it will be dubbed something like ‘Bank Reverse Management Operations’ (BRMO) or ‘Treasury Market Liquidity Operations’ (TMLO). The Fed could take a leaf from China’s playbook, since her Central Bank the PBoC, now uses a long list of monetary acronyms, such as MTL, RRRs, RRPs and now ORRPs, probably to hide what policy makers are really doing.

And indeed, the Fed announced on Dec 10 that it would purchase $40 billion in T-bills in the very near term, with more purchases to follow.

But is this really (the unseemly) QE of years past? Cooler heads argue that no, it is not. Traditional QE has focused on longer-term securities (e.g. T-bonds or mortgage securities with maturities perhaps 5-10 years), in an effort to lower longer-term rates. Classically, QE was undertaken when the broader economy was in crisis, and short-term rates had already been lowered to near zero, so they could not be lowered much further.

But the current purchases are all very short-term (3 months or less). So, this is a swap of cash for almost-cash. Thus, I am on the side of those saying this is not quite QE. Almost, but not quite.

The reason given for undertaking these purchases is pretty straightforward, though it would take more time to explicate it that I want to take right now. I hope to return to this topic of system liquidity in a future post.Briefly, the whole financial system runs on constant refinancing/rolling over of debt. A key mechanism for this is the “repo” market for collateralized lending, and a key parameter for the health of that market is the level of “reserves” in the banking system. Those reserves, for various reasons, have been getting so low that the system is getting in danger of seizing up, like a machine with insufficient lubrication. These recent Fed purchases directly ease that situation. This management of short-term liquidity does differ from classic purchases of long-term securities.

The reason I am not comfortable saying robustly, “No, this is not all QE” is that the government has taken to funding its ginormous ongoing peacetime deficit with mainly short-term debt. It is that ginormous short-term debt issuance which has contributed to the liquidity squeeze. And so, these ultra-short term T-bill purchases are to some extent monetizing the deficit. Deficit monetization in theory differs from QE, at least in stated goals, but in practice the boundaries are blurry.

Can the President Fire a Member of the Federal Reserve Board of Governors?

Zachary Bartsch1 Comment

That’s exactly what he tried to do this past Monday. Trump announced on social media that Lisa Cook, appointed by Biden in 2022, is now fired. Things are about to get awkward.

First, Trump can’t simply fire Fed governors willy-nilly. Remember when DOGE was involved in all of those federal workforce lay-offs earlier in the year? I know, it seems like forever ago. The US Supreme Court ruled on the legality of those firings, including some at government corporations and ‘independent agencies’. The idea behind such entities is that they are supposed to be politically insulated and less bound by the typical red tape of the government. But Trump’s administration argued that the separation from the rest of the executive branch is a fiction and that there is no one else in charge of them if not the president. The Supreme Court agreed with the administration, with one exception.

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Organization of the Federal Reserve – OR, Why The President is Impotent against the Fed

Zachary Bartsch3 Comments

In my recent post that included Federal Reserve political independence, I dared to use the word ‘trust’, and commenters let me know that they were not pleased about it. In strict economic terms, there is no such thing as trust. Either that, or it’s the same thing as expectations or maybe low-information expectations. Since it wasn’t the main thrust of my post, I didn’t lay-out the informed reasoning behind my confidence in President Trump’s inability to cause Argentina or Turkey or even 1970’s US levels of political influence on the Fed.

In short, I’m not worried about it because the operational structure of the Fed and the means by which individuals join the Fed are determined by congress and are pretty robust. Below is a diagram that I made. I know that it’s a lot, but I’ll explain below.

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Forecasting the Fed: Description Vs Prescription

Zachary BartschLeave a comment

After raising rates in 2022 to belatedly combat inflation, the FOMC was feeling successful in 2024. They were holding the line and remaining steadfast while many people were getting all in a tizzy about pushing us into a recession. People had been predicting a recession since 2022, and the Fed kept the federal funds rate steady at 5.33% for an entire year. Repeatedly, in the first half of 2024, betting markets were upset that the Fed wasn’t budging. I had friends saying that the time to cut was in 2023 once they saw that Silicon Valley Bank failed. I remained sanguine that rates should not be cut.

I thought that rates should have been higher still given that the labor market was strong. But, I also didn’t think that was going to happen. My forecasts were that the Fed would continue to keep rates unchanged. At 5.33%, inflation would slowly fall and there was plenty of wiggle room for unemployment.

Then, we had a few months of lower inflation. It even went slightly negative in June 2024. Some people were starting to talk about overshooting and the impending recession. I documented my position in August of 2024. Two weeks later, Jerome Powell gave a victory lap of a speech. He said that “The time has come for policy to adjust”.  Instead of discerning whether the FOMC would cut rates, the betting markets switched to specifying whether the cut would be 0.25% or 0.5%. The Fed chose the latter, followed by two more cuts by the end of the year.

https://fred.stlouisfed.org/graph/?g=1DIsX

I was wrong about the Fed’s policy response function. But why? Was the FOMC worried about the downward employment revisions? That was big news. Did they think that they had inflation whipped? I’m not sure. There was a lot of buzz about having stuck the soft landing. In late 2024, I leaned toward the theory that the Fed was concerned about employment. Like, they thought that we had been doing better until then.

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Recession Prospecting & Fed Tea Leaves

Zachary Bartsch4 Comments

Will a recession happen? It’s famously hard/impossible to predict. Personally, I have a relatively monetarist take. I consider the goals of the Federal reserve, what tools they have, and how they make their decisions. I also think about the very recent trend in the macroeconomy and how it’s situated relative to history. Right now, the yield curve has been inverted for quite some time and the Sahm rule has been satisfied, both are historical indicators of recession.

Recessions are determined by the NBER’s Business Cycle Dating Committee. They always make their determination in hindsight and almost never in real time. They look at a variety of indicators and judge whether each declines, for how long, how deeply, and the breadth of decline across the economy. So plenty of ‘bad’ things can happen without triggering a recession designation.

In my expert opinion, recessions can largely be prevented by maintaining expected and steady growth in NGDP. This won’t solve real sectoral problems, but it will help to prevent contagion and spirals.  The Fed can control NGDP to a great degree. In doing so, they can affect unemployment and growth in the short run, and inflation in the medium to long run.

One drawback of the NGDP series is that it’s infrequent, published only quarterly. It’s hard to know whether a dip is momentary, a false signal that will later be updated, or whether there is a recession coming. So, what should one examine? One could examine leading indicators or the various high-frequency indicators of economic activity. But those are a little too much like tarot cards and fortune telling for my taste.

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Rate Cuts Looking Dubious for 2024

Scott Buchanan3 Comments

Fellow blogger James Bailey and I have noted earlier this year that with inflation having  plateaued well above the target 2% level, and with the ongoing strength in the U.S. economy, the three (initially six) rate cuts that pundits predicted for 2024 may not materialize. In fact, we may get no rate cuts at all. This has implications for many things, including housing markets and investing. Also, high interest on the federal debt, layered on top of insane peacetime budget deficits (neither party is willing to tell we the people that we cannot have big spending and low taxes), means the debt will balloon. Sorry about that, grandkids.

Here is a graphic which illustrates the course of inflation as measured by the Consumer Price Index:

It seems that inflationary expectations are now firmly embedded into wage growth (which is the driver for the increase in Service costs). This mindset way be tough to break. Such is the fruit of the Fed’s head in the sand, inactive approach to raging inflation back in 2021. Instead of nipping it in the bud, they blandly assured us, “It’s just a transitory response to supply shocks”.

One very recent (yesterday) data point is the Census Bureau’s Advance Report on Monthly Sales for Retail & Food Services. This report provides initial data on consumer spending at U.S. retail establishments for March 2024; this is a valuable, timely indicator of current economic activity. According to the Census, Retail Sales expanded by +0.72%, surprising to the upside by +0.32%. This economy just isn’t slowing down.

Slow Landing versus No Landing

The dominant expectation among economists as 2023 drew to a close was that the economy would slow down significantly, gradually enough to justify Fed rate cuts, but it would not crater so fast as to bring on a recession. Now there is more and more talk of a “No Landing” scenario, where GDP keeps chugging along and rates stay high, as the new normal.

Yahoo Finance summarized the recent thinking of Wells Fargo:

The Wells Fargo Investment Institute piled on to that narrative in a note Monday upgrading its outlook for the U.S. economy. While the bank didn’t specifically predict a “no landing” outcome, researchers lifted their gross domestic product growth forecast from just 1.3% for 2024 to 2.5%—the same as last year’s rate of 2.5%.

Wells also said the U.S. unemployment rate will sit at 4.1% instead of 4.7% by the end of 2024. The tradeoff will be slightly higher inflation. The bank now sees U.S. CPI inflation of 3%, instead of its previous 2.8% estimate.

Several factors have been named to account for the unexpected strength of the U.S. economy over the past few years, including record fiscal spending, particularly on infrastructure and semiconductors; the housing market’s resilience to higher rates owing to post–Global Financial Crisis policy changes and supply issues; and even “greedflation.”

But Wells Fargo said the economy has outperformed expectations because financial conditions—a measure of the availability and cost of borrowing, as well as risk and leverage in financial markets—are actually accommodative, despite the Fed’s rate-hiking campaign.

To that point, the Chicago Federal Reserve’s National Financial Conditions Index has been in accommodative territory throughout the Fed’s hiking cycle, and decreased to –0.53 in the week ended April 5—its lowest level since February 2022.

Unless there is a sudden change, it looks unlikely to me that the Fed can cut in May or June or July. If they do not cut by August, the thinking goes, it becomes likely that they will not cut at all this year, because of the optics around the fall election.

San Francisco Fed Says Pandemic Surplus Is Gone; Boston Fed Demurs

Scott Buchanan2 Comments

Is it the best of times or the worst of times? This question I asked myself as I saw the following three headlines juxtaposed last week:

“US consumers are in the best shape ever” is sandwiched between two downers. The American consumer’s ongoing spending has staved off the long-predicted recession, quarter after quarter after quarter. Can we keep those plates spinning?

We noted earlier that the huge windfall of pandemic benefits (direct stimulus plus enhanced unemployment benefits) put trillions of dollars into our bank accounts, and the spending down of that surplus seems to have powered the overall economy and hence employment (and inflation). How the economy does going forward is still largely determined by that ongoing spend-down. Thus, the size of the remaining hoard is critically important.

Unfortunately, it seems to be difficult to come up with an agreed-on answer here. The San Francisco Fed maintains a web page dedicated to tracking “Pandemic-Era Excess Savings.” Here is a key chart, tracking the ups and downs of “Aggregate Personal Savings”:

This is compared to a linear projection of pre-pandemic savings, which is the dotted line. (Which dotted line you choose is crucial, see below) . The next chart plots the cumulative savings relative to that line, showing a steady spend-down, and that this excess savings is just about exhausted:

If this represents reality, then we might expect an imminent slowdown in consumer spending and in GDP growth, and presumably a lessening in inflationary pressures, which may in turn justify more rate cuts by the Fed.

But the Boston Fed says, “Maybe not.”  A study by Omar Barbiero and Dhiren Patki published in November titled Have US Households Depleted All the Excess Savings They Accumulated during the Pandemic? showed that it makes a huge difference which savings rate trend you choose for a baseline.

The following chart shows two versions of the first plot shown above, with (on the left) a linear, increasing projection of 2018-2019 savings trends, versus a flat savings rate baseline:

Two significant differences between these plots and the San Francisco Fed plot shown above are that these plots only run through the end of 2022, and that they display per cent savings rate rather than dollar amounts. However, they demonstrate the difference that the baseline makes. Using an increasing savings rate baseline (2018-2019 trend projection), the surplus was nearly exhausted at the end of 2022. Using a flat rate average of 2016-2019 for the baseline, the surplus was barely dented.

We will see how this plays out. My guess is that at the first whiff of actual recession and job losses, the administration will gush out the maximum amount of largesse; while we may have ongoing inflation and high interest rates due to the deficit spending, we will not have a hard landing. I think.

“The Biggest Blunder in The History of The Treasury”: Yellen’s Failure to Issue Longer-Term Treasury Debt When Rates Were Low

Scott Buchanan3 Comments

That extra $4 trillion or so that the feds dumped into our collective checking accounts in 2020-2021 – -where did it come from? Certainly not from taxes. It was created out of thin air, via a multi-step alchemy. The government does not have the authority to simply run the printing presses and crank out benjamins. The  U.S. Treasury sells bonds to Somebody(ies), and that Somebody in turn gives the Treasury cash, which the Treasury then uses to fund government operations and giveaways. In 2020-2021, the Somebody who bought all those bonds was mainly the Federal Reserve, which does have the power to create unlimited amounts of cash, in exchange for government bonds or certain other investment-grade fixed income securities.

What is causing a bit of a kerfuffle recently is public assessment of what sorts of bonds that Janet Yellen’s Treasury issued back then. Interest rates were driven down to historic lows in that period, thanks to the Fed’s monster “quantitative easing” (QE) operations. The Fed was buying up fixed income hand over fist: government bonds, mortgage securities, even corporate junk bonds (which was probably illegal under the Fed’s charter, but desperate times…). This buying frenzy drove bond prices up and rates down.

All corporate CFOs with functioning neurons and with BB+ credit ratings refinanced their company debt in that timeframe: they called in as much of their old bonds as they could, and re-issued long-term debt at near-zero interest rates. Or they just issued 5, 10, 20 year low-interest bonds for the heck of it, raising big war-chests of essentially free cash to tide them through any potential hard times ahead. And of course, millions of American homeowners likewise refinanced their mortgages to take advantage of low rates.

What about the federal government? Was the Treasury, under Secretary  Yellen, similarly clever? No, not really. Because there is little serious doubt that the U.S. government will be able to pay its debts (grandstanding government shutdowns aside), the government can always find takers for 20- and 30-year bonds, as well as shorter maturity securities. A mainstay of government financing is the 10-year bond. And in 2020-2021, the Fed would have consumed whatever kinds of bonds the Treasury wanted to sell, so the Treasury could have issued a boatload of long-term bonds.

It seems that the Treasury issued a lot of 2-year bonds, rather than longer-term bonds. If they had issued say ten-year bonds, the government would have had a decade of enjoying very low interest payments on that huge slug of pandemic-related debt. But now, all those 2-year bonds are being rolled over at much higher rates and thus much greater expense to the government. (Since the federal debt only grows, almost never shrinks, maturing earlier bonds are not simply paid down, but are paid by issuing yet more bonds).

Veteran hedge fund manager Stanley Druckenmiller (reported net worth: $6 billion) commented in an interview:

When rates were practically zero, every Tom, Dick and Harry in the U.S. refinanced their mortgage… corporations extended [their debt],” he said. “Unfortunately, we had one entity that did not: the U.S. Treasury….

Janet Yellen, I guess because political myopia or whatever, was issuing 2-years at 15 basis points[0.15%]   when she could have issued 10-years at 70 basis points [0.70 %] or 30-years at 180 basis points [1.80%],” he said. “I literally think if you go back to Alexander Hamilton, it is the biggest blunder in the history of the Treasury. I have no idea why she has not been called out on this. She has no right to still be in that job.

Ouch.

Druckenmiller went on:

When the debt rolls over by 2033, interest expense is going to be 4.5% of GDP if rates are where they are now,” he warned. “By 2043—it sounds like a long time, but it is really not—interest expense as a percentage of GDP will be 7%. That is 144% of all current discretionary spending.

Unsurprisingly, Yellen demurs:

 “Well, I disagree with that assessment,” Yellen said when asked to respond to the accusation during an interview on CNN Thursday night. She said the agency has been lengthening the average maturity of its bond portfolio and “in fact, at present, the duration of the portfolio is about the longest it has been in decades.”

According to Druckenmiller, this is not quite true. It does seem that of the federal bonds held by the public (including banks), the average maturity (recently as long as 74 months) has indeed been a bit longer than usual in the past several years. However, this ignores the huge amount of government bonds held at the Fed:

“The only debt that is relevant to the US taxpayer is consolidated US government debt,” Druckenmiller said. “I am surprised that the Treasury secretary has chosen to exclude $8 trillion on the Fed balance sheet that is paying overnight rates in the repo market. In determining policy, it makes no sense for Treasury to exclude it from their calculations.”

Druckenmiller makes an important point. However, how this plays out depends on how the Fed treats these bonds going forward. If the Fed keeps these bonds on its balance sheet, and buys the replacement bonds, there will be actually very little interest expense to the government going forward. The reason is that the Fed is required to remit 90% of its profits back to the Treasury, so the gazillions of interest payments on those bonds and their replacements will largely flow right back to Treasury. However, if the Fed continues with reducing its balance sheet, forcing the Treasury to go the open market to roll these bonds over, Druckenmiller’s dire warnings will prove correct.

Because of this enormous debt overhang and the ongoing need for the government to sell bonds, I do not expect interest rates to go down as low as 2021 or even 2019 levels, unless there is a financial catastrophe requiring the Fed to become a gigantic net buyer of bonds once again.

Easy FRED Stata Data

Zachary Bartsch1 Comment

Lot’s of economists use FRED – that’s Federal Reserve Economic Data for the uninitiated. It’s super easy to use for basic queries, data transformations, graphs, and even maps. Downloading a single data series or even the same series for multiple geographic locations is also easy. But downloading distinct data series can be a hassle.

I’ve written previously about how the Excel add-on makes getting data more convenient. One of the problems with the Excel add-on is that locating the appropriate series can be difficult – I recommend using the FRED website to query data and then use the Excel add-on to obtain it. One major flaw is how the data is formatted in excel. A separate column of dates is downloaded for each series and the same dates aren’t aligned with one another. Further, re-downloading the data with small changes is almost impossible.

Only recently have I realized that there is an alternative that is better still! Stata has access to the FRED API and can import data sets directly in to its memory. There are no redundant date variables and the observations are all aligned by date.

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Why Have Economists Continually Underestimated Projected Inflation?

Scott Buchanan5 Comments

I keep reading about how inflation has peaked (even peaked many months ago) and so any minute now the Fed will relent on raising interest rates, and will in fact start reducing them. Every data point that seems to support an early Fed pivot and a gentle “soft landing” for the economy is greeted with optimistic verbiage and a rip higher in stocks.

Except – – other meaningful data points regularly appear which show that inflation (especially core inflation) is remaining stubbornly high. The Personal Consumption Expenditures (PCE) Index is the Fed’s preferred way to track core inflation. It did peak in early 2022, and is falling, but very slowly and fitfully. Just when it seems like it is about to cascade downward, along comes another uptick.  The latest report for 02/24/23 showed the PCE index (excluding the volatile categories of food and energy) increasing 0.6 percent during the month of January, which translated to a 4.7 percent year-on-year gain. That was considerably higher than the 0.4 percent monthly gain (4.3 percent year-on-year) that economists expected.

Source: MV Financial

The chart below illustrates the chronic tendency of the economists at the Fed to lowball the estimates of future inflation. Each of the ten bars depicts quarterly projections of what inflation would be for 2023, starting back in September 2020 (first, green bar).  No one in the craziness of 2020 could be held particularly responsible back then for accurately projecting 2023 conditions. But the Fed embarrassed themselves badly into late 2021 by airily dismissing inflation as “transitory”, due mainly to supply chain constraints that would quickly pass. (See towards the middle of the chart, yellow Sept 2021 and blue Dec 2021 bars projecting a mere 2.2% inflation for 2023.)

Source: Jeremy LaKosh

Only as of December 2022 did estimates of inflation jump up to 3.1% for 2023, and that estimate will surely get revised upward even further.

Many factors probably went into this systematic failure on the part of the Fed economists. There are probably political reasons for erring on the rosy optimistic side, which I will not speculate on here.

One factor in particular was mentioned in the Minutes of the Jan 31/Feb 1 Fed meeting that I thought was significant:

A few participants remarked that some business contacts appeared keen to retain workers even in the face of slowing demand for output because of their recent experiences of labor shortages and hiring challenges.

Jeremy LaKosh notes regarding this feature, “If true across the economy, the idea of keeping employees for fear of facing the labor force shortage would represent a fundamental shift in the employment market. This shift would make it harder for wage increases to mitigate towards historical norms and keep upward pressure on prices.”

This all rings true to my anecdotal observations. In bygone days, when business slowed down, factories would lay off or furlough workers, with the expectation on all sides that they would call the workers back (and the workers would come back) when conditions improved. However, employers have had to struggle so hard this past year to find willing/able workers, that employers are loath to let them go, lest they never get them back. I have read that even though homebuilders are not sure they can sell the houses they are building, they are so worried about losing workers that they are keeping them on the payroll, building away.

Other inflation data points show big decreases in prices for goods (and energy), but not for services. Wages, of course, are the big driver for service costs.

So the inflation story in 2023 seems to come down largely to a labor shortage. This is a large topic cannot be fully addressed here. I will mention one factor for which I have anecdotal support, that the enormous benefits (stimulus money plus enhanced unemployment) paid out during 2020-2021 set up a large number of baby boomers to leave the workforce early and permanently. Studies show that this is a major factor in the drop in workforce participation rate post-Covid. Maybe some of those folks had not planned ahead of time for such early retirement, but they got a taste of the good life (NOT getting up and going to work every day) in 2020-2021 along with the extra cash to pad their savings, and so they decided to just not return to work. That exodus of trained and presumably productive workers has left a hole in the labor force which now manifests as a labor shortage, which drives up wages and therefore inflation and therefore interest rates, which will eventually crater the economy enough that struggling firms will finally lay off enough workers to mitigate wage gains.

I wonder if this unhappy scenario could be staved off with increased legal migration of targeted skilled workers from other countries to alleviate the labor shortage. Dunno, just a thought.