Sept 27. Fed’s Stein suspects other investors have influence on bond yields; more research needed. :- l
–Relatively quiet yesterday as yields backed up slightly after the recent rally. Auctions concluded with a somewhat soft 7 yr, but the ten year yield only rose 2.7 on the day to 2.64. Implied vol was better bid, perhaps not surprising given congressional shenanigans related to a shutdown.
–Yesterday’s GDP Price change was +0.6, the lowest since the depths of the crisis. Today Personal Income and Spending expected +0.4 and +0.3, but also, and more importantly, Core PCE prices expected +0.1. The Fed uses Core PCE as a preferred measure of inflation, and of course has a dual mandate with respect to inflation and employment.
–Fed’s Stein gave an interesting speech yesterday, which in my opinion was all about the difficulty of removing QE. He theorizes that a “recruitment channel” that induces bond investors to reach for yield was in large measure responsible for the change in rates to the downside, and subsequently to the upside. To which I say, “Duh”. From Stein: “If the Fed’s control of long term rates depends in substantial part on the induced buying and selling behavior of other investors, our grip on the steering wheel is not as tight as it otherwise might be.” (Surprisingly enough, some people have a problem with career academics running Fed policy). He also says this, and it’s likely true and important: tighter financial conditions have “brought term premiums closer into line with historical norms, and thereby arguably reduced the risk of a more damaging upward spike at some future date.” The point is that these other investors have partially unwound their “reach for yield” but the Fed has no real way to control their (volatile) behavior. So he concludes that a strictly mechanical rule be put in place, for example tying the pace of QE to the unemployment rate. This line of thought, tying monetary policy more mechanically with specific economic data such as employment and inflation, is gaining credence with all central banks. Interestingly, the Indian Central Bank head (who Stein mentions in his speech), is shifting to CPI as his guide for changes in monetary policy. Strange dichotomy that in the US, with PCE prices well below target, that employment is more of a guide, while in India, a currency crisis is making inflation fighting a top priority. But both want more “mechanical” decision making. What if you choose the WRONG data to tie policy to? What if that data is flawed? (For example labor participation rate skewing unemployment rate or Core PCE not capturing the inflation viscerally felt by US households).
