Karim writes:
Not a game changer in my view and doesn’t compel the Fed to change course next week.
Private sector gradually churning out jobs; hours, wages, and diffusion index ok.
- Private payrolls up 71k after avg of 41k of prior 2mths but well off highs of 200k avg of Feb and Mar
- UE rate stays at 9.5%
- Hours up 0.3% and wages up 0.2%
- Diffusion index up to 55.6 from 55.2
- Median duration of unemployment down from 25.5 to 22.2
- U6 measure unch at 16.5%
- Job growth accelerates in manufacturing and retail; weakens in temp services and leisure/hospitality
Yes, which means it remains a good market for stocks.
High unemployment is good for cost control and helps keep the Fed on hold. And 0 rates remain a deflationary influence as well.
Top line growth is modestly positive growing by productivity increases plus some hours and employment gains.
Earnings trend remains positive with productivity gains, some top line growth, and a loose labor market.
All supported by a federal deficit that still exceeds 8% of gdp.
Tough political environment with most of the real wealth going to the top as unemployment remains near the highs.
Government (including Fed) is still operating on asset-value (wealth) model instead of demand (income) model. Obama is apparently getting tired of his job and is looking to become a one-term president. Or, he will say later, with Bill Clinton, “I received bad advice” from the Rubin Group.
Warren,
I am not a banker but it was my understanding the Fed was paying banks to hold reserves. If I was a bank I would think that a guaranteed, no-risk return from the government is better than loans to the public (which may not pay back).
Seems like eliminating this this would encourage lending. Then it would unlock the expansion triggered by credit flowing.
Am I missing something?
Thanks,
Marcello
@Marcello:
Normally I wait for WM to answer these but since I think I can field this and since he’s pretty busy these days I thought I’d chime in.
Banks don’t loan out their reserves so the “hold reserves vs. make loans to the public” calculation is a false choice.
The Fed is paying interest on reserves, which does indeed cause banks to hold excess reserves instead of loaning them out on the interbank lending market, but it doesn’t have a direct effect on lending to the public.
If I try to go farther in this space I’ll say something that isn’t quite right, but I’d recommend this NY Fed paper, which WM has linked to several times.
http://www.newyorkfed.org/research/staff_reports/sr380.pdf
Yes, exactly.
Also, it’s very important to understand that at any time, not just now, a bank’s expected return on a loan has to be greater than the risk-free rate. Even without payment of interest on rbs, banks can always hold Treasuries instead of lending, though you never heard anyone complaining before payment of interest on reserves that there were all these Treasuries circulating that reduced banks’ incentives to make loans.
In the aggregate, banks as a whole have no choice but to hold the rbs created by previous Fed actions–only changes to the Fed’s balance sheet can affect the agg qty of rbs.
I don’t know for sure, but I would doubt banks on the whole are overly excited about holding the rbs beyond what they need to settle payments and meet rr, as they earn the fed funds rate yet they end up with probably very little spread over the offsetting liability, and then there’s the non-interest costs of those additional liabilities, as well. I haven’t looked carefully at the effect of interest on rbs on banks’ actual financials, but I did put together my own spreadsheet to play around with it a bit; there are some scenarios where bank ROE improves with interest on rbs, and some where it gets worse. The latter are most likely obviously where the spread of the FFR versus corresponding liabilities is smallest, which would tend to be more likely the closer the FFR gets to zero–and it can’t get all that much closer to zero than it is now, obviously. At the same time, though, I haven’t seen much if any press regarding banks complaining about holding so many ER, so this does call for more research, for sure.
Scott is too modest to mention that the single best discussion of the this issue is a paper written by one Scott T. Fullwiler, “Paying Interest on Reserve Balances: It’s More Significant Than You Think”.
http://www.cfeps.org/pubs/wp/wp38.html
Scott can correct me if I have this wrong, but it appears that the high level of bank reserves are simply an artifact of IOR payments (first authorized in the 2008 TARP bill) channeling money towards reserve accounts instead of Treasuries.
If there were no IOR payments, the public debt would simply be that much higher. Of course, this begs the question of why the Tsy issues interest-bearing debt anyway instead of just issuing new money (US Notes or coins) and pegging the federal funds rate with IOR payments.
Wow, that is a fantastic paper. Thanks.
lending in the interbank mkt just moves the reserve balances to that other bank. the total stays the same
the total reserves in the banking system will be the same whether the Fed pays interest on them or not.
they are set by govt action, not markets or individual bank behavior.
When I try to talk to people about the monetary system, this part always seems to trip me up:
“The “crowding out” view of the loanable funds market is irrelevant; the rates on various types of Treasury debt are set by the current and expected paths of monetary policy and according to liquidity premia on fixed-rate debt of increasing maturity.”
This is, as I’ve seen it stated elsewhere, the idea that “long-term rates are the sum of short-term rates.” This seems simple enough to me but I am not able to explain it to people who don’t already agree with it. Is there an authoritative explanation of this idea that I could read somewhere?
Two sources come to mind quickly.
First, pages 22-30 of my paper “Interest Rates and Fiscal Sustainability” at cfeps.org cite a number of folks (McCulley, Bernanke, etc.) and there are some interest graphs.
Second, my latest favorite–which I think would be a very good summary of the views of MMT’ers, and probably articulated more clearly than any of us have to this point–is from ESM as a response in comment #9 at http://moslereconomics.com/2010/05/21/krugman-has-it-right/ in which he/she says:
I think Warren was trying to account for risk premia in his catch all phrase “supply technicals.” I can vouch for the fact that out to 18 mths, the yield curve is completely driven by expectations of the short rate as set by the Fed. A risk premium really starts to kick in around 2 years, but the curve out to 10 years is mostly driven by reference to rates for shorter maturities. So the Fed really does have quite a bit of power to nail down the yield curve.
Between 10 and 20 years, things become very technical because liquidity in the Treasury market is not good in that range of maturitied. Beyond 20 years, convexity effects kick in, so projections of market volatility are incorporated into the rates at these maturities (this is why the curve tends to become negatively sloped beyond 25 years or so).
The Fed does not have a lot of power to determine 30 year rates, but I can guarantee you that if the short rate is 25bps, there are quite a few bond traders who will find a 30-year bond at 5% yield pretty attractive. The positive carry on a leveraged position is hard to resist.
the fed could announce it will buy any 30 year tsys at 2% and I assure you 30 year tsy rates would be no higher than that.
🙂
Of course. The comment was referring to the case that the Fed only sets the overnight rate, though.
I think the important thing is that there has to be a risk premium that is in some sense proportionate to time – i.e. proportionate to duration. So the yield curve is determined by:
Expected policy rate path + risk premium + technicals
Where technicals relate to specific supply/demand issues at various points on the curve
It is not correct however to suggest there is no risk premium out to 18 months. There is always a risk premium of some magnitude – nobody “knows” the future and nobody “knows” future fed policy. That said, technicals at a point in time may have directional effects that move yields higher or lower from there.
And the Fed always wins, as yields roll down the curve, as bonds age.
Another fact is that the Fed determines neither the risk premium nor the technical factors – i.e. there are factors beyond the Fed’s control in the determination of the yield curve. It is only expected rates where the Fed and the market fairly coincide.
Anon,
Good points.
Do you agree with this :
The very short end is closely tied to the Fed funds rate. There is however no expectation of the central bank reaction function out to 30 years! There is a market segmentation and the Fed and the Treasury make use of it. While they are doing that, they also indicate the monetary policy stance but thats rough because neither the Fed/Treas nor the private sector know the future. If yields at some segments are high, the Fed/Treas reduces supply at those levels, causing movement of yields at those points. (Of course, yields move also because of changes of preferences of investors). The point about this is that the markets themselves do not adjust to some expectations, but the central bank and the Treasury work toward getting it across. In the middle of all this, they are also making sure that the composition is correct and that not too many bonds mature around the same time.
The expectations theory on the other hand gives the central bank and the Treasury a passive role.
risk of what?
the risk is the risk of what the fed might do to both short and long term rates.
the risk to what they may do with the policy rate is what I meant
30 years in fact is very sensitive to Fed policy – just very volatile – not so much due to expected reaction 29 years from now, but 30 year prices can move violently based on short term expectations for Fed policy that ripple out and get magnified by the duration sensitivity of the bond – leveraged reaction to shorter term expectations so to speak
Certainly Treasury manages its term structure of debt
The Fed can be active in smoothing term structure pricing anomalies through intervention – I don’t think this is huge though
i.e. the front end of the curve has a magnified effect on implied forward expectations out to 30 years
Yeah .. I was talking about the Fed advising the Treasury.
OK, I don’t have any problem with any of that. It all sounds pretty good to me and consistent with the MMT’ers views. Term premium definitely is proportionate time, ceteris paribus. Randy and Warren have often noted the supply/demand technicals, as well.
The one thing I would add is that I read a paper a few years ago that found that most of the “conundrum” of the mid-2000s term premium could be explained by a reduction in risk regarding the expected future path of rates (can’t recall the exact technique, but it had to do with the implied volatility in options on FF futures). I’d always thought that this should logically be a factor in the term premium or in adjusting the term premium given the rising potential losses of holding longer dates (perhaps there’s a better way to explain the relation of this risk to the term premium and duration/convexity?), and the paper at least suggested there might be some truth to that.
Krugman has also written some interesting, pithy stuff recently about the yield curve being more option like at the short rate zero bound – asymmetric risk in that sense – which would be an explanation for a curve that is still notionally steep even while long rates are at historic lows.
yes, i’ve been writing about that and trading accordingly from the time japan’s rates went low enough for that to kick in. option traders picked it up only many years after we had used it successfully