Dollars and Jens
Thursday, January 31, 2008
Upcoming Interest Rate Hikes
Investors in fed funds futures contracts immediately assumed that was an indication the target would be cut again by another 25 basis points at the next FOMC meeting on March 18, or by 50 or maybe even 75.

Actually, by mid-March, it might be clear that the U.S. economy isn't in as much trouble as a lot of investors think it is because they're shocked by the plunge in housing construction and sales and by the subprime-related losses at several major banks and brokerages.

Rather than more rate cuts, 2008 may see a replay of 1988, when the Fed quickly raised rates to control inflation after the growth scare caused by the October 1987 stock market crash dissipated. The sheer size of the Fed's easing may ensure that.
He makes a case for it.

Wednesday, January 30, 2008
GDP was only up at a 0.6% rate in Q4; domestic consumption wasn't all that weak, but production was weaker, and inventories sold off. A small boost from net exports, but not as much as the previous quarter; fixed residential investment continues to be a substantial direct drag — we have yet even to reach the inflection point here — and of course is probably an indirect drag as well.

Let's break it into its components:
.6% 3.8% 4.9% .6%
PCE 2.56
Inventories-.65 .22 .89 -1.25
Fixed investment-.70.49 -.11 -.39
Net Exports-.511.32 1.38 .41
Government Spending-.09 .79 .74 .50
"Inventory accumulation" is classically lumped in with fixed investment as "investment", but I find fixed investment tends to be less volatile and inventory adjustment's impact is, on a short term basis, negatively correlated with consumption, and negatively serially correlated with itself; in short, looking at trends, I like to throw about half of it away and put the rest with consumption. Anyway, you can see the big change from the stronger growth earlier in the year is from inventory accumulation; meanwhile, domestic consumption started to drop off a bit, and net exports didn't help nearly as much as they had been.

Tomorrow is NIPA, and the Dallas Fed's trimmed-mean PCE; Friday is the employment report.

Update: "PCE" in the table is actual Personal Consumption Expenditures; the figure I'm awaiting from the Dallas Fed tomorrow is the price deflator on PCE.

Fed policy
50 bps. Plosser voted with the group, but Fisher wanted no change.

A lot of data the next couple days. A bit of data today, too. Separate post.

monetary policy
Enough is enough. It's time for Ben Bernanke and the rest of the Fed to pull a page from Tony Danza's book and show investors who's the boss.

Yes, the economy is teetering on the edge of a recession, if it isn't already in one. But the Fed has already cut the fed funds rate by 175 basis points since September.
Well, maybe. At the moment, the fed funds target sits closer to where it did at the top of the cycle than to its last bottom, though that might no longer be true in fourteen hours.
Fisher, as an alternate member of the Fed's policy-making Open Market Committee last year, did not vote on the 2007 rate cuts. But he will be a committee member this year. So his opinions are worth paying attention to.
I tend to think Fisher's opinions, like those of his predecessor Robert McTeer, are generally worth paying attention to.

He warned that the Fed still has only two mandates, fostering price stability and supporting economic growth. Keeping the markets happy is not a new third mandate.

"Our job is not to bail out imprudent decisionmakers or errant bankers, nor is it to directly support the stock market or to somehow make whole those money managers, financial engineers and real estate speculators who got it wrong. And it most definitely is not to err on the side of Wall Street at the expense of Main Street," he said.
The fed certainly, in the process, needs to anticipate the effect of Wall Street on Main Street in deciding what interest rate is appropriate; there may be some room for trying to influence financial markets for the same reason, but that can get dangerous in a hurry. If the fed cut rates last week because it was going to cut them anyway and felt the timing would reduce the likelihood of an economy-weakening stock market event, I have no problem with that.

Initial claims of unemployment have been dropping for the past month, and based on what I know, I'd be leaning against a 50bp cut, but I have more confidence in the fed than I do in me.

Monday, January 28, 2008
Good Capitalists and Bad Capitalists
This is unusual - Sebastian Mallaby draws a distinction between "good capitalists" and "bad capitalists", and the hedge funds are the good guys. It caught me by surprise, as I expect hedge funds to be vilified; his argument is that, unlike some players, the hedge fund managers generally have substantial wealth tied up in their own funds and therefore have better incentives to manage risk appropriately. A seven billion dollar loss won't cost the fund manager seven billion dollars, but it will cost him more than just his job, and may even cost him something comparable to what a seven billion dollar gain would gain him.

Tuesday, January 22, 2008
a quiet day
My brother noticed, before I did, that stock markets around the world spent Monday and Tuesday crashing; I got into work a bit late and was a bit surprised by the media presence around the NYSE this morning, but figured it was probably just normal for the beginning of a trading week and I hadn't really paid close enough attention before. And, you may know, American stocks crashed today, but the fed cut interest rates 75bp this morning, so that the dollar fell only 1% less. (Or you can think of it however makes sense to you; I just happen to have seen charts of exchange rates from when the announcement was made.)

The vote wasn't unanimous; there are two vacancies on the board of governors, and Mishkin was unavailable, leaving 9 voters, one of whom was Bill Poole — I'm pretty sure he's rotating off as a voting member, but that must not take place until next week — who didn't feel a move was necessary a week before a regular meeting. The way that was reported rather makes it look like this cut was in place of a big cut next week, though markets are still pricing in a cut then, too, and the guys at work who get paid to think about these things think they'll get bullied into another 50bp whether that's their current plan or not.

The timing is a bit curious if you're trying to defend the Fed against accusations of placing a "put" on the market — much as Bill Poole seems to have thought — and it might well behoove them to resist bullying next week. Full-scale financial meltdown tends to have less than salutary effects on the real economy, and some response to global financial events was probably appropriate; if this cut was indeed an attempt to shore up the real economy, its timing at least was clearly driven by the markets, and unless next week's data look really, really bad, it's hard to imagine that enough new data will have accrued between meetings to justify 125 bp.

Through the year of the 5.25% fed funds target, I viewed policy as slightly tight, but very close to neutral; I still think neutral is around 4.5%. They're now a full point below that; if you believe inflation is no lower than the optimal rate, and you take the Taylor rule as Taylor introduced it, with coefficients of 0.5, a one percentage point difference between the new target rate and "neutral" would be appropriate for an output gap of 2%. The fed views long-term growth potential as being somewhat below 3%, last I heard; another 50bp tells you that either the fed sees something else recommending a lower rate than I've spelled out — perhaps they have a figure lower than 4.5%, or they think the economy is less responsive to interest rates than Taylor was using, or something else — or the fed thinks we're heading to (or in) recession.

The long end of the bond market, incidentally, saw rates down several basis points, which was a relief to me — and almost certainly to the fed voters as well, who no doubt would have found themselves in a tricky spot if bonds had sold off.

Monday, January 21, 2008
Black Tuesday
Happy Black Tuesday! (I know I'm 13 hours early, but it's close enough.)

UPDATE: I guess the Fed didn't want to celebrate Black Tuesday with me.

Tuesday, January 15, 2008
It is now looking as though the funds target is more likely to be 3.5% than 4.0% at the end of the month; there are reasons for the fed to be hesitant to get too happy with the rate cuts, but the producer price index report today was pretty benign, the consumer price index tomorrow may well follow suit, and the labor market right now looks like a bigger concern than inflation.

Incidentally, swap spreads have come down further, the term-loan auction went off below 4%, and the credit crunch looks generally to be abating somewhat — though it's hard to imagine that will go away as a concern in the next six months. At the moment, though — given current data — it makes me think you try a 50bp cut rather than 75 right away. I believe the Fed may have access to early versions of the January employment report when it has its meeting in two weeks, though; if something there looks dire, you might see any lingering hawkishness, even at that level, melt away a bit.

mortgage fraud
I've been wondering what the full implications would be of a short-term amnesty, waiving criminal penalties against borrowers who lied on their mortgage applications if they 'fess up quickly. It seems likely that it would have little beneficial effect unless one or more lenders also waived civil liability — if a "right to sue" can't generally be waived, perhaps allowing it here would be part of the same legislation. The issues in the credit markets in particular are in large part a function of pervasive ignorance of its scale; perhaps at least bringing some of this into the light would have a palliative effect there.

Oh, and if I haven't predicted it before: in about five years, the political pendulum will have swung or will be swinging back in the other direction, criticizing lenders for not making enough loans to bad credits.

fiscal stimulus
One relatively neutral way to put $100B into the economy in a single, Keynsian kick is to have the federal government pay, from general funds, the employee portion of the social security tax for three months. If what you're worried about, though, is an employment slowdown driving an economic slowdown, Bryan Caplan notes that Singapore does this right: "When there is a surplus of labor, they cut employers' share of the payroll tax", which, in a sticky-wages world, should bring the labor market back to equilibrium more quickly than would otherwise happen.

Friday, January 11, 2008
trade deficit
The U.S. trade deficit in November surged to the highest level in 14 months, reflecting record imports of foreign oil. The deficit with China declined slightly while the weak dollar boosted exports to another record high.

The Commerce Department reported that the trade deficit, the gap between imports and exports, jumped by 9.3 percent, to $63.1 billion. The imbalance was much larger than the $60 billion that had been expected.
That jump is a bit more than someone hoping an improving balance of trade will cushion the economic slow-down might have hoped to see. I'd like to note, though, that the U.S. trade deficit jumped 9.3% in dollars; if you measured it in euroes, for example, it would be a few percentage points less. The way this enters real GDP will be with price changes in imports and exports divided out, so to the extent that this number is driven by high oil prices driving up the value of imports, it will show up as inflation but not as a drag on real growth.

(It seems to me this is likely to be a common effect of currency devaluation in a country with a trade deficit: in the short term, at least as measured in the local currency, the trade deficit is likely to get worse, though in real terms, and probably in the longer term in terms of domestic currency as well, the tendency to drive global consumption toward that country's products would reduce the trade deficit. This assumes short-term price stickiness that would reduce over longer time-horizons, and might be a smaller effect in the United States than in other countries insofar as a lot of globally traded products are invoiced in U.S. dollars — if prices are sticky in the domestic currency of the country under consideration, import and export prices won't correlate with currency devaluation the way I've assumed here.)

(Lest anyone be confused by this: the rising price of oil here wasn't necessarily due entirely to the drop in the dollar. Insofar as it was, this is a generalized phenomenon relating the effects of a depreciating currency. Insofar as it wasn't, it's an idiosyncratic event that will still flow into inflation numbers rather than real growth numbers.)

Friday, January 04, 2008
employment situations

By which I mean, er, I'm somewhat disappointed with these numbers.

The establishment survey, to be honest, isn't that bad — payrolls expanded (if barely), wages continued on their 5% annual pace. The household result, on the other hand, is a disaster. They're intended to measure slightly different things, but this discrepancy is still a bit extreme, and one tends to imagine the actual health of the labor market to lie somewhere between the numbers we see here. If retail sales and other numbers later this month are at all tepid, the fed has a wide opening to cut the target 25 or even 50 bp.

Incidentally, the January fed funds future is still several bp away from the current target, and moved more so today. It's hard to say whether this is an actual bet on a pre-meeting change in the target or simply a willingness on the part of the open market desk to let rates fall a bit short of that target; the rate over Monday (and Tuesday) night was just 3.01%, though year-end is a bit strange, but that per se shouldn't have affected a change today in the value of the future.

Wednesday, January 02, 2008
CAFE standards
Chrysler will be fined for missing its CAFE quota, and this detail is interesting to me:
The fine for violating CAFE standards is $5.50 for ever tenth of a mile under the 27.5 mpg goal, multiplied by the number of vehicles imported.
If most of the vehicles are in the general vicinity of that 27.5 mpg, $55 per mpg is basically $1 per gallon per million miles, multiplied by the number of miles a vehicle goes in its lifetime; using 200,000 miles, we get 20 cents per gallon.

At least in one form, the new energy bill was to make CAFE credits tradable, and I was given the impression that this was likely to make it into the final version. If you do this, make the CAFE requirement higher than is likely to be met, and start doing your averages and assessing your fines in terms of gallons per mile rather than miles per gallon — perhaps adjusting for lifetime mileage differentials — you're pretty much left with a tax that's legally incident on the car companies but has the same effect, on certain margins, as a 20 cent per gallon gas tax.1 On other margins it has the same problems as CAFE always has had vis-a-vis a gas tax: it can actually reduce the marginal cost (to the driver) of driving more miles. If the CAFE limits are just barely achieved, mileage will have been improved as a result of them, but the prices of high-mileage cars will be lower than without CAFE standards, and driving two 60 mpg cars is cheaper, relative to the non-CAFE world, than car pooling in a 40 mpg car; the latter uses more gas. The gas tax gets this exactly right automatically; if a 40 mpg car goes 120 miles, it pays taxes on 3 gallons of gas, while two 60 mpg cars making the trip would incur taxes on 4 gallons of gas.2

1 Without the change in the calculation of averages and fines, you're over-taxing degradations in the gas mileage of cars that already use little gas, and under-taxing them in gas guzzlers, so that if two fleets of the same number of vehicles use the same amount of gasoline, the one with more uniform gas mileages will pay higher taxes than the one with a lot of guzzlers and hybrids. I wouldn't expect much political resistance to this technical correction, though I don't think I have a great intuition on those things, but I also don't think it would make all that big a difference in practice.

2 You get back to a gas tax on this margin as well if you're willing to raise the CAFE requirement to infinity. (If you do that, the "technical correction" becomes more important.) This rather blows the façade off the notion that a mandate is being imposed and a fine assessed for failing to meet it, rather than allowing the market to do things in the efficient way without heavy-handed top-down controls. For all its successes, efficiency seems less politically popular than heavy-handed micromanaging.

Tuesday, January 01, 2008
Charlie Munger
Happy Birthday to Berkshire Hathaway vice chairman Charlie Munger, who is 84 today.

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