Oct 23. Did the FED crash the neutral rate?
–Nikkei continues a powerful rally as Abe swept Japanese elections. Just since the beginning of September the Nikkei is up around 12%! Over the same time frame US rates have generally increased. Not sure if there’s causation, but I certainly would not stand in the way of Japanese stocks.
–Yellen gave a swan song speech on Friday night, reviewing the Fed’s response to the crisis. From the speech:
“….our unconventional policy tools will likely be needed again should some future economic downturn drive short-term interest rates back to their effective lower bound. Indeed, empirical analysis suggests that the neutral federal funds rate…is much lower than in previous decades. Consequently, the probability that short-term interest rates may need to be reduced to their effective lower bound at some point is uncomfortably high, even in the absence of a major financial and economic crisis.”
Yellen discusses several policy tools, one of them being forward guidance. In some ways, the above snippet acts on its own as forward guidance. What Yellen never addresses, and I think it’s a key question, is this: Were the Fed’s unconventional policy tools responsible to some degree for LOWERING the neutral rate???
–The last several speeches touch upon the idea of creating policy room for the next downturn. It’s a fairly common underlying theme, and the seed that is planted (with all the subtlety of a Trump tweet), is that the Fed MAY HAVE TO BUY BONDS AND OTHER SECURITIES AGAIN.
–Friday saw rates close at the high of the week, with tens up 5.6 bps to 237.9. The curve bounced back from lows of the year made in the early part of the week, with 2/10 closing above 80 bps, +3.1 on the day. Heavy selling in EDZ7 9850 straddle which settled at 6.5 with 8 weeks to go! Supply of 2,5 and 7 year notes starting Tuesday.
