Fed's Kohn: ZIRP is a Price Stability Strategy, Or Maybe Let's Do More QE First
I find it interesting that Bloomberg chooses a piece on 2y T-bills to slip in a Donald Kohn winner. Live from Jackson Hole: It's Central Banker Clusterfuck!
Fed Vice Chairman Donald Kohn said the central bank’s current policy to keep rates low for a long time is aimed at promoting price stability and not at spurring inflation.
“The commitment to low rates is designed to keep inflation from falling and falling persistently below what we might want it to be for a long time,” Kohn said on Aug. 22 during an audience-debate period at a the Jackson Hole symposium. “It’s not designed to raise inflation expectations. There’s no inconsistency there.”
Kohn was responding to a presentation by Carl Walsh, a professor at the University of California at Santa Cruz, suggesting the Fed’s stance is “potentially inconsistent” with its low-inflation goal and “requires careful balancing.” The Fed cut its main rate to between zero and 0.25 percent in December and has pledged to leave it there for an “extended period.”
In December 1992, the gap between two-year yields and the Fed’s target rate jumped to 183 basis points. By the following March, it had narrowed to 74 points after traders realized they’d jumped the gun in anticipating higher borrowing costs. Policy makers didn’t raise rates until February 1994. In September 2003, the spread hit 103 basis points before contracting to 44 in October, nine months before the Fed moved.
Even after the Aug. 21 tumble, the odds of a Fed rate increase this year are just 13 percent, down from 24 percent a month ago, futures data on the Chicago Board of Trade show.
“The two-year yield will remain extremely low” as the Fed keeps rates unchanged “deep” into 2010, said Stephan Hirschbrich, who manages 1.3 billion euros ($1.86 billion) as head of international bonds at Union Investment in Frankfurt.
Most forecasters are convinced two-year yields are heading up. Even Hirschbrich, who’s holding off on buying Treasuries until yields rise, foresees 1.25 percent within six months.
All but six of 47 economists and strategists in a Bloomberg survey see higher yields by January. The median forecast of 1.35 percent, up from April’s 1.05 percent prediction, would increase the spread to the Fed target rate for overnight loans between banks to as much as 110 basis points, more than twice the average of 46 basis points over the past 20 years.
O rly? Fascinating. I think focusing on 2years when considering the threat of inflation is silly at best.
So is looking to the UK for our monetary cues:
If all goes according to plan, the $300 billion effort will run its course in October. All along, Fed officials have worried than the program would spook investors into thinking they were “monetizing the debt” – which is econospeak for facilitating big, inflationary budget deficits by buying government debt with money the Fed simply prints. Such a perception in the market could make the program backfire and push long-term rates higher instead of lower.
With that background in mind, it’s worth noting a comment that Fed Vice Chairman Donald Kohn made from the audience this weekend at the central bank’s Jackson Hole meetings. He was struck, he noted, that interest rates on British gilts fell earlier this month after the Bank of England re-upped its plans to buy government bonds. The program in the U.K., in other words, seemed to be having its intended effect, evidence supporting its usefulness. “The markets must perceive that there is an effect there,” he noted during a panel discussion on monetary policy.
The Fed has said it doesn’t intend to expand or extend its bond-purchase program. But what if the economy underperforms? And what if evidence mounts that this program, or others like it such as the U.K.’s, actually did have their intended effect? Maybe it won’t be dead after all. The Fed can be expected to keep its options open on the question.
The markets are on LSD, they don't know what they perceive right now.