Fed: Case for Rate Increase Has Strengthened The Federal Reserve left short-term interest rates unchanged, but signaled after a meeting marked by internal divisions that it still expected to raise them before year-end.
Fed Chairwoman Janet Yellen offered an upbeat assessment of the economic outlook, noting that growth has picked up after a dismal first half, with household incomes growing solidly and workers rejoining the labor force in search of jobs after years of not looking. (…)
“We judged that the case for an increase had strengthened but decided for the time being to wait for continued progress toward our objectives,” she said at her press conference following the Fed’s two-day policy meeting. (…)
Ms. Yellen said those changes were a recognition that productivity growth “is likely to remain low for an extended time.” (…)
In its postmeeting policy statement on Wednesday, the Fed said risks had become “roughly balanced,” meaning the economy has just as good a chance of exceeding the Fed’s growth estimates as of falling short. (…)
- Even the cautious Fed is getting antsy to raise rates.
- 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.
Central Bank Tools Are Losing Their Edge Central banks have shown the will to hit their growth and inflation targets. But do they have the way? That question is more pointed after the Bank of Japan on Wednesday announced two new central bank firsts. (Greg Ip)
(…) On Wednesday, the bank blamed three factors for inflation’s failure to reach 2%: the plunge in oil prices, a consumption-tax increase in 2014, and a slowdown in emerging markets. (…)
The bank hopes that committing to overshooting its inflation target will push expectations higher, but it admits that “may take time” given how low actual inflation remains.
The bank also acknowledged constraints on its ability to push rates more deeply into negative territory, noting that “an excessive decline” in rates can hurt the economy by raising doubts about the financial system’s long-term health.
Japan’s economic plight shouldn’t be exaggerated. Its unemployment rate is the lowest in more than 20 years. While economic growth has been close to zero, that is partly due to a shrinking workforce and poor productivity growth.
For the same reason, the differences between Japan and other countries aren’t that great. U.S. unemployment, at 4.9%, is close to the Fed’s view of its natural level, yet economic growth has been sluggish for years. Inflation and inflation expectations remain depressed.
What’s notable about the Fed’s announcement wasn’t the expected hint that it will raise rates again soon, but that there will be fewer rate increases thereafter than previously expected.
The most sobering disclosure was that officials now peg the U.S.’s long-term growth rate at 1.8%, down from 2% in June and 2.5% in 2011. “We’re struggling with…what is the new normal in this economy and in the global economy, which explains why we keep revising down the rate path,” Fed Chairwoman Janet Yellen told reporters.
The forces behind this combination of low growth and low rates go well beyond things central banks can influence. One is demographics.
Aging populations are shrinking the workforce and customer base, which saps incentives for capital expansion. Economists at Barclays noted that Japan’s shift from elderly to younger workers, from manufacturing to less-productive services, and from permanent to temporary employment are all depressing wages.
Second, productivity growth is stagnant, for reasons that aren’t clear. A third reason is fiscal tightening—efforts by governments to cut their deficits that ballooned after the recession.
Given all this, what are central banks to do? The answer, quite possibly, is nothing, or at least nothing more than what they’re now doing.
Though their policies have been less effective than hoped, they haven’t been ineffective, and if nothing derails the global economy, wages and inflation should continue to recover.
(…) the Bank of Japan’s decision to target a zero yield on government bonds might reassure the Japanese government that it can run bigger deficits without triggering a jump in interest rates. That echoes the Fed’s pegging of bond yields in the 1940s to help the Treasury fund World War II.
The war effort produced a massive economic boom. The Fed’s job was to hold yields down in the face of so much Treasury borrowing and pent-up inflation pressure.
Today, there isn’t any similar pressure on yields from borrowing or inflation. Indeed, the Bank of Japan’s zero-bond-yield target is higher than the negative yields bonds have recently carried. The lesson is that while central banks have tools at their disposal, there is only so much they accomplish by themselves.
Yen’s Rally Makes Bank of Japan’s Job Tougher The yen surged more than 1% against the dollar Wednesday, extending a sharp 2016 rally and marking an ominous start to the Bank of Japan’s latest bid to rouse a struggling economy.
(…) But the bigger risks may stem from two of the world’s major central banks trying to do very different things at the same time.
The BOJ’s targeting of long-term Japanese government bond yields, for example, will alter Japanese investors’ appetite for U.S. Treasurys — and will therefore influence long-term interest rates in the U.S. The Fed’s plan to raise short-term rates at the same time that the BOJ, through its commitment to overshoot its inflation target, is signaling it will keep short-term rates negative for a very long time, could shift global money flows in other ways. (…)
After reading most everything on the BOJ and Fed statements, the only solid conclusion that can be reasonably reached is that nobody really knows what’s going on and how to really boost economic activity.
The BOJ’s decision to target prices (or yields) rather than quantity is puzzling in many aspects but makes it clear that there will be less liquidity created as a result. This while the Fed is trying as much as it can to release itself from QEing. Meanwhile, the ECB is finding it difficult to buy bonds, sovereign or corps, as there is not as much supply as expected.
The risk is less liquidity to sustain financial markets and declining confidence that solutions are still available.
But the hunt for riskfull yield continues (Ycharts.com):
Meanwhile, it looks like corporations are also winding down their own form of liquidity management:
Profits and buybacks: going on a bear hunt Bearish predictions are coming true; why isn’t the market falling?
(…) It is worth noting, therefore, that two predictions dear to the boo-boo brigade are showing signs of coming true. Prediction one: profit margins are very high by historical standards and will revert to the mean (explanations for high margins include under-investment, technology defanging competition, and heavy government deficit spending). At any rate, S&P 500 margins are coming down. National accounts data shows something similar in the broad economy. Part of this is down to commodity companies, but not all: margins in, for example, tech and telecoms are slipping too.
Prediction two: the cash flowing towards share buybacks will not keep growing forever. In the second quarter, buybacks were flat from the year before and took a sharp step down from the first quarter. Perhaps steadily rising corporate debt is having a damping effect. Again, the national accounts confirm the trend. Companies (as opposed to individuals and institutions) have been the only consistent net buyer of shares for years. If the companies back off, the bears say, the indices will fall.
Well, the indices are not falling. Soon the bears will need new theories. The most popular will, without doubt, involve rate suppression by the US Fed keeping discount rates down and therefore shares up. Terrible returns on cash and debt securities surely forces some money into shares. The “low rates keep stocks high” argument may fall away too, though. It is easy to find historical instances where it did not work that way. Stocks could rise right along with rates, especially if the economy is strong. On to the next theory, then.
Some key charts from Factset’s recent Buyback Quarterly:
In this first chart, note the drop in the number of companies repurchasing shares:
During the quarter, 350 companies engaged in share buybacks, which was a significant decrease from the 380 participants in Q2 2015. The second quarter marked the lowest buyback participation rate since Q4 2010, when only 337 firms in the index performed share buybacks. Over the last 12 quarters, the average number of S&P 500 companies repurchasing shares was 381.
Approving buybacks is getting more difficult to justify as profits decline and debt rises: