Geo-Graphics

Do Fed doves and hawks get their aviary classifications based on their cold, hard analysis of data, or is it the reverse – do they select data points to justify their dovish or hawkish perspectives? The history of the Fed’s post-crisis focus on unemployment suggests the latter.  After June of 2013, as the figure above shows, the Fed’s estimate of the natural long-term unemployment rate begins declining in sync with the decline in the actual unemployment rate.  This suggests that FOMC members are lowering their estimates of the natural rate of unemployment to justify keeping interest rates at zero longer than they could if they stuck by their initial estimates, the 6% consensus upper bound of which is now above today’s actual 5.9% rate. We cannot test this hypothesis directly, by checking each member’s estimate history, because the estimates are anonymous.  But we can check whether the phenomenon can be explained merely by a change of FOMC composition: it cannot. The distribution of participants’ estimates shows conclusively that some of them have indeed revised their estimates lower.  Given that these are supposed to be estimates of the "long-term" natural unemployment rate, this is more than curious. With core PCE inflation, the Fed’s preferred inflation measure, running at 1.5%, still comfortably below the Fed’s 2% long-run target, there is little compelling reason to begin hiking rates immediately.  But given its upward trajectory from 1.2% at the start of the year, there is surely now reasoned cause for bringing forward the Fed’s old September 2012 calendar-guidance of zero rates through mid-2015 – which the Fed doves are still strongly wedded to. Our observations suggest that monetary dovishness and hawkishness are often fixed states of mind, rather than artifacts of a consistent approach to data analysis.  If so, there is reason to fear that the Fed’s exit from monetary accommodation will be too late and too tepid – with the result being higher future inflation than the market is pricing in right now. Financial Times: Jobs Data Show United States Beating Global Economy Wall Street Journal: Falling Unemployment Alone Not Reason To Raise Rates, Fed’s Kocherlakota Says Yellen: Perspectives on Monetary Policy Orphanides and Williams: Monetary Policy Mistakes and the Evolution of Inflation Expectations   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Russian president Vladimir Putin is determined to wean his country off the dollar, or so he says. In July, after insisting that the international monetary system depended too much “on the U.S. dollar, or, to be precise, on the monetary and financial policy of the U.S. authorities,” Putin signed off on a new BRICS development bank whose initial paid-in capital would be entirely in dollars – unlike the World Bank, where only 10% of paid-in capital was in dollars.  So the new BRICS bank actually creates a new source of demand for dollar assets. Now, he wants to diversify Russia’s holdings in its two sovereign wealth funds (SWF), the Reserve Fund and National Wealth Fund, away from dollars – and euros as well.  Finance minister Anton Siluanov has announced that funds will soon be directed into financial assets issued by its fellow BRICS nations – Brazil, India, China, and South Africa. There are some caveats, however.  Siluanov suggested that the shift would be mainly into “Eurobonds issued under English law,” which effectively means dollar- and euro-denominated bonds.  As the figure above shows, however, total international bond issuance by Brazil, India, China, and South Africa amounts to only $45 billion, or a mere 26% of the holdings of Russia’s SWFs.  Furthermore, Russia’s two funds are currently restricted to investments in securities rated AA- or better by Fitch, or Aa3 or better by Moody’s.  Only China’s international bonds meet these criteria, which would leave Russia with a potential pool of investable assets worth a mere $1.5 billion – less than 1% of Russia’s SWF assets. Russia could, of course, relax the constraint that the bonds be issued internationally, in hard currency, and invest in local currency bonds.  Brazil, for example, which Siluanov singled out as an investment destination, has issued about $800 billion worth of local-currency bonds.  But the Brazilian Real has depreciated by 10% against the dollar in the past month alone, and “capital preservation” is a fundamental investment objective of Russia’s SWFs.  With Russian capital flight approaching dangerous levels (Fitch projects $120 billion for this year), and rumors flying that capital controls will be imposed to staunch the outflow, would Russia really be willing to bet its solvency on the Real in order to make a political point of little or no consequence for the dollar’s global reserve status? Not a chance. Ministry of Finance of the Russian Federation: National Wealth Fund Wall Street Journal: Did Russia Just Move Its Treasury Holdings Offshore? TesouroNacional: Brazil Federal Public Debt Annual Borrowing Plan 2014 Bank of Russia: International Reserves of the Russian Federation   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”

Market expectations for Fed policy have been decidedly more dovish than the Fed itself, a conundrum that is concerning San Francisco Fed economists.  As the Fed debates its rate-liftoff forward guidance this week, however, it is worth asking how much it really matters. We have long argued that the market has been perfectly rational in tuning out elements of central-bank forward guidance that aren’t credible.  Today’s Geo-Graphic shows why the market may well have it right again. As the figure above shows, going back to 1992 the Fed has never raised rates less than 225 days after the end of a policy-easing cycle.  In 1992, the gap was 518 days.  In 1996 and 2003 the gap was also over a year. So with QE3 set to wind down in October, the market has history on its side in expecting a later transition to tightening (beginning this time next year), and a slower one, than Fed forecasts and statements suggest. Reuters: Fed to Drop “Considerable Time” Next Week, Top Economist Says Wall Street Journal: Can the Fed Drop “Considerable Time” Without Spooking Markets? Financial Times: Fed Should Raise Rates Sooner Than Later Yellen: Perspectives on Monetary Policy   Follow Benn on Twitter: @BennSteil Follow Geo-Graphics on Twitter: @CFR_GeoGraphics Read about Benn’s latest award-winning book, The Battle of Bretton Woods: John Maynard Keynes, Harry Dexter White, and the Making of a New World Order, which the Financial Times has called “a triumph of economic and diplomatic history.”