SPECIAL REPORT: Fed. Promises More QE! And Reverses Aggressive Hike Stance. By Gregory Mannarinoby Gregory Mannarino , Published on Feb 23, 2018
https://www.youtube.com/watch?v=TMMbdxYI1Gs
SPEECH
Comments on "A Skeptical View of the Impact of the Fed's Balance Sheet"February 23, 2018
https://www.newyorkfed.org/newsevents/speeches/2018/dud180223
"William C. Dudley (https://www.newyorkfed.org/newsevents/speeches/2018/dud180223), President and Chief Executive Officer
Remarks at the 2018 U.S. Monetary Policy Forum, New York City As prepared for delivery
It is a pleasure to be able to comment on this year's U.S. Monetary
Policy Forum paper. As always, what I have to say here today reflects
my own views and not necessarily those of the Federal Open Market
Committee (FOMC) or the Federal Reserve System.1
To say that I was interested in this year's topic is an understatement.
The use of the Federal Reserve's balance sheet has been an important
element of U.S. monetary policy over the past decade. The start of the
reversal of that expansion—the so-called process of balance sheet
normalization—has been a key focus of the FOMC's monetary policy
deliberations over the past year. I am pleased that the start of this
process—in contrast to the bond market taper tantrum of 2013—has been
non-disruptive. The normalization process is now running in the
background, essentially on autopilot, with short-term interest rates
serving as the primary tool for adjusting the stance of monetary policy.
Let me start with my main point: Although I agree with many of the
authors' findings in this year's paper, I would take a much less
skeptical view of the Federal Reserve's balance sheet as a tool of
monetary policy. While additional study of the effects of large-scale
asset purchase (LSAP) programs should be encouraged—as it furthers our
understanding of the use of these unconventional monetary policy
tools—the paper's findings do not, in my mind, invalidate the use of
LSAPs when the Federal Reserve is operating at or close to the zero
lower bound for short-term interest rates. That is the key issue—not
the magnitude of the effects of LSAPs or whether short-term interest
rates should be the primary tool of monetary policy. On the latter
point, which is consistent with the FOMC's statements about policy
normalization, I see broad agreement.
Concluding that LSAPs are less powerful than suggested by some of the
estimates from the event study literature does not imply that there is
no role for LSAPs at the zero lower bound. In such circumstances, LSAPs
can be used to provide additional monetary accommodation by depressing
bond term premia and the spread between agency mortgage-backed
securities (MBS) and Treasury securities, as well as by strengthening
the credibility of forward guidance on the path of short-term interest
rates. This can provide support to asset values more generally and make
financial conditions more accommodative. Thus, discarding such a tool
or ruling out its use seems counterproductive for two reasons. First,
to the extent that such a tool can provide accommodation, ruling out
its use would raise the risks of insufficient monetary policy
accommodation when interest rates are pinned at the zero lower bound.
Second, expectations matter. If households and businesses believe that
the Fed has run out of tools to provide monetary policy accommodation
or is unwilling to use certain tools for that purpose, the risk of
inflation expectations becoming unanchored to the downside would
increase, which would make it even more difficult for the central bank
to achieve its goals. For these reasons, LSAPs should be viewed as a
viable tool in our arsenal to be used when the zero lower bound is a
relevant policy concern.
In terms of calibration, if LSAPs are not as powerful as some of the
event studies imply, the answer is not to simply discard the tool, but
instead to look for ways to enhance its efficacy and use it more
aggressively. In this respect, I believe that LSAPs work best when they
are open-ended. In such circumstances, the use of the tool is likely to
be helpful in reducing tail risks and making the bad states of the
world less likely rather than signaling to market participants a
significant deterioration in the Federal Reserve's outlook. LSAPs may
also be a useful means of making forward guidance more credible. If the
monetary authority were to commit to a program of asset purchases until
some economic objective is reached and, at the same time, were to make
it clear that the policy rate would not begin to rise until the asset
purchase program were completed, these steps might help anchor
expectations about the likely path of short-term rates more
effectively. The Federal Reserve's third round of LSAPs, which was
open-ended, was an important innovation of policy that the paper might
have discussed in greater detail.
I also don't agree with the paper's conclusions about agency MBS
purchases. Such purchases do not represent "credit easing" as argued in
the paper. The government's interventions to support Fannie Mae and
Freddie Mac have made it clear that there is no credit risk in the
Federal Reserve's purchase of such obligations. Also, the authors don't
acknowledge that the ability to purchase agency MBS has two benefits.
First, it enables the Federal Reserve to purchase longer-duration
assets at a faster pace without disrupting market functioning. This
facilitates larger LSAP programs, when a larger program is viewed as
necessary. Second, it opens up another channel by which asset purchases
can provide stimulus—by narrowing the spread between agency MBS and
Treasuries, the Federal Reserve can drive down long-term mortgage rates
and provide support to the housing sector and to home prices. When
monetary policy is constrained at the zero lower bound for interest
rates, being able to purchase agency MBS seems like a good tool to have
available.
I am also a bit baffled by the conclusion that the Fed should "consider
larger and looser caps, possibly specified in terms of quarterly rather
than monthly changes, with caps perhaps removed completely by 2019." It
seems to me that the current process of balance sheet normalization is
proceeding very smoothly. We placed caps on redemptions because we
wanted to limit the potential for market disruption that might occur if
the amount of securities that had to be absorbed by private markets
fluctuated unduly. The cost of the caps in terms of delaying the
shrinkage of the balance sheet is very low. Even if the caps were to be
removed completely at the end of 2018, it would most likely pull
forward the timing of normalizing the balance sheet size by only two
quarters. The delay due to the caps is small because, when they are
fully phased in, they are likely to be binding only for Treasuries and
then only in the middle month of each quarter.
While I don't agree with some of the broader conclusions of the paper,
I do agree that a healthy skepticism about event studies is warranted.
The major theme of the paper is that event studies that have sought to
measure the impact of the Federal Reserve's three major LSAP programs
are flawed for a number of reasons. These include potential selection
bias of the events chosen and the fact that event studies may not
capture all the factors that influence how market prices respond to
LSAP announcements.
The first problem with event studies, of course, is the issue of how
much new information is revealed by the actual policy announcement. I
would argue that LSAPs were always a possibility, so the probability of
their use never went from 0% to 100%, even for the first LSAP program.
This suggests that event studies could lead to downwardly biased
estimates of the impact of LSAPs. In fact, if the announcement
indicated that the program was smaller than expected, then bond yields
could rise on the program's announcement. This scenario could occur
even though the overall program—including its anticipation—was
effective in reducing yields. This makes interpreting the direction of
changes in bond yields on the day of an announcement difficult.
The second problem with event studies is that there are always other
things going on. When the Fed announces an LSAP program, long-term
rates might drop because of the announcement, or because market
participants were revising downward their views about the state of the
economy and the economic outlook in light of the Fed's actions. Or,
conversely, long-term yields could conceivably even rise as market
participants became more confident that the policy actions would be
sufficient to push the economy toward the central bank's goals of
maximum sustainable employment and price stability.
The third problem with event studies is the difficulty in disentangling
the various factors behind the moves in long-term yields. If an
open-ended LSAP program pushes back the perceived timing of short-term
rate hikes, it will be difficult to apportion the impact on long-term
yields between LSAPs and an expectation of a flatter path for
short-term rates.
These conclusions argue for putting less reliance on event studies to
measure the impact of LSAPs, rather than more. In this regard, I would
advocate taking a different tack: rely more on an evaluation of bond
term premia to assess the potential impact of LSAPs. Bond term premia
currently are unusually low, and I suspect that LSAP programs here and
abroad have been an important factor. Evaluating the factors that have
been affecting bond term premia over time might be a good alternative
way of estimating the impact of LSAPs.
To sum up, while the impact of LSAPs on long-term bond yields is likely
lower than what is implied by some of the event study literature, this
does not mean that LSAPs aren't a useful tool when the FOMC is
constrained by the zero lower bound. LSAPs can not only narrow bond
term premia, but also make forward guidance more credible. Thus, LSAPs
remain useful to have in the toolkit for those times when the
short-term interest rate tool may not be available.
1 Lorie Logan and Paolo Pesenti assisted in the preparation of these remarks. "
Next up for markets: New Fed Chair Powell weighs in on the interest rate debate * Fed Chair Jerome Powell's testimony next week is the next big
catalyst markets are watching, hoping the new central bank chair
will be a referee in the tug-of-war between stocks and bonds.
* Ahead of his testimony, the Fed is scheduled to release its
Monetary Policy Report on Friday morning, a blueprint of sorts for
his comments.
* Powell may stray from the report with his personal outlook next
week, and markets are watching for comments on inflation and
interest rates after Wednesday's wild reaction to the minutes from
Janet Yellen's last meeting.
Patti Domm | @pattidomm
Published 3:06 PM ET Thu, 22 Feb 2018 Updated 22 Hours Ago
https://www.cnbc.com/2018/02/22/next-up-for-markets-new-fed-chair-powell-weighs-in-on-the-interest-rate-debate.html