After a day which was spent waiting to see what the FOMC would do equity markets in America closed virtually unchanged with the Dow up 7 and the S&P 500 falling 2.93 points. However their performance has been very strong recently with the S&P 500 having risen some 8.92% so far in September so perhaps you could say they maintained their recent high levels. If we move onto the topic of Japan’s currency intervention then we are starting to see quite a divergence between its effect on the two main currencies it was supposed to fall against. The Yen has begun to strengthen against the US dollar again and is now at 84.89 whilst it is much weaker at 113.01 versus the Euro. Indeed the Euro is strong all round at 1.33 versus the US dollar and 1.18 versus the UK pound sterling. If we return to another theme of this blog,the lack of economic competitiveness of some of the peripheral euro zone nations, this recent rise in the Euro will do them no good at all if it is sustained.
After yesterday’s extraordinary rise in the fats and oils,and livestock component of the CRB spot index I did wonder if we would see a setback today. However the index rose to 479.86 which means that over the past twelve months it has now risen by 25.8%. The biggest component influence was textiles which rose by more than 1% on the day and even after their surge yesterday the livestock component rose by more than 1/2%.
The FOMC Statement
The FOMC made no overt change in monetary policy and at that point in my view one should let out a sigh of relief. Fortunately the pressure on them had released a little in the run-up to the meeting. As an example of this better US housing starts figures had been released earlier in the day, as the 598,000 recorded in August was an improvement on the revised (down) figure for July of 541,000. However there had been a flurry of suggestions pre-meeting that the FOMC might relax its inflation target to say 3%. These had echoes of the recent IMF working paper that suggested that the world economic situation might be improved by central banks raising their inflation targets to 4%.
What did the Fed say of significance?
There was a significant change in the statement’s view on inflation.
Measures of underlying inflation are currently at levels somewhat below those the Committee judges most consistent, over the longer run, with its mandate to promote maximum employment and price stability. With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to remain subdued for some time, before rising to levels the Committee considers consistent with its mandate.
This is a more definite statement that the one made in August. Also it has echoes of Chairman Ben Bernanke’s speech at Jackson Hole when he said.
“if deflation risks were to increase, the benefit-cost trade offs of some of our policy tools could become significantly more favorable.”
If you remember he had listed four policy tools that he felt that the FOMC could deploy and expresses his confidence that they could deal with any outbreak of deflation. So we have a hint that the FOMC is looking at inflating the economy and maybe an implication that it will try to operate this time through the price of goods and services rather than asset prices. After all some asset prices such as the stock market levels I was discussing earlier have improved substantially but economic performance is still “unusually uncertain” to quote Mr. Bernanke again.
We then got a further confirmation that a rise in inflation might be welcomes by the FOMC with again the implication that policy will be set to achieve this.
The Committee will continue to monitor the economic outlook and financial developments and is prepared to provide additional accommodation if needed to support the economic recovery and to return inflation, over time, to levels consistent with its mandate.
The change here is that the objective is no longer price stability but has changed to inflation consistent with the mandate. As currently the FOMC’s inflation measure the Consumer Price Index is at 1.1% it is below its mandate and we can accordingly expect the FOMC if it keeps its word to try to inflate the economy and this time raise the general price levels rather than asset prices as an objective.
It is interesting that the FOMC is overtly talking about inflation and implying that it will act to move it higher. At the moment it will look to achieve its current target which implies expansion as inflation is below target, but there is perhaps also a slight hint that if this does not do the job then the FOMC may act in the fashion suggested by some commentators and the IMF of aiming for a raised inflation target.
Some years ago a British band Elvis Costello and the Attractions released a song which in a couple of lines sums up my view of this new strategy from the FOMC.
Pump it up until you can feel it.
Pump it up when you don’t really need it.
Although they were not quite fully prescient as we could do with a line expressing doubts as to whether it will work.
The Market’s View
If you were an investor expecting inflation and a debasement of the currency then you might buy gold and sell the US dollar. As I reported earlier the dollar did fall against the Yen, Euro and Pound. Indeed this adds to a recent trend of dollar depreciation which sits somewhat oddly with the statements from US Treasury Secretary Geithner and others which in effect accuse other nations of doing precisely this to achieve a competitive advantage. A case perhaps of pot to kettle. The US trade-weighted dollar index is now at 80.03 and has fallen by around 10% since the spring of this year.
Gold also rallied and continued a strong recent trend. The Comex gold futures price rallied to US $1291 per ounce making it a happy trading day for gold bugs and a rise of 1.3% on the day. As it is an instrument considered to be a guard against inflation and the debasement of fiat or paper money I guess its rise was no great surprise as the FOMC statement was digested.
Another way to look at this might be to look at the performance of Treasury Inflation-Protected Securities as they are the instrument which would be most directly affected by a change in FOMC policy. There is a five-year TIPS and its view on inflation has risen from 2% to 2.55% over the past month or so and yesterday it rose from 2.46% to 2.55% making it a good day for investors in inflation linked bonds too. Just to explain a rise in expected inflation means that prices have risen. Somewhat more oddly conventional bonds rose on the news too but perhaps they were just humming the song I quoted from earlier.
I would also like to repeat a theme of my blog at this point. If QE 1 has not worked then how will repeating or increasing it with QE 2 work exactly?
Euro zone government bond auctions
Yesterday saw a bond auction in a troubled area for the euro zone, Ireland. This has been widely reported as a success but as ever one needs to define success. In terms of being able to issue debt and receive funding then yes it was as the Irish Treasury will receive 1.5 billion Euros. However one also needs to look at the yield paid as Irish taxpayers will have to fund this. The yield on the four-year bond was 4.78% and on the eight-year it was 6.02%. If we look at my update on Monday I suggested this for the eight year bond.
If we look at Friday’s levels the four-year bond is likely to be below this yield level but the nearest bonds to an eight year benchmark yielded 5.97% and 6.14% respectively so well over.
My point is that the bond was issued in effect at Friday’s closing levels. So my suggestion is that if you read somewhere that this is a success you check further and see what that individual thought of the closing yield levels on Irish government bonds on Friday. You may find some inconsistency there.
Indeed if we remind ourselves that funding is available from the IMF at around 3% and from the EFSF at around 5% you may reasonably wonder why this route was not taken to save Irish taxpayers some money. As they pay the bill for the next eight years they may not be quite so clear that this operation was a success.
Today sees an auction from Portugal who currently is also facing higher government bond yields. Her ten-year government bond yield is at 6.34% and this accordingly will also lead to eyes shifting to the potential for cheaper funding as discussed above for Ireland. Her problems will not have been helped by the news that on the latest figures the central government’s fiscal shortfall rose to 9.19 billion euros from 8.74 billion euros a year earlier according to her Finance Ministry.Remember this is supposed to be the year of austerity and cuts not rises and Portugal has failed to reduce government spending. The target of reducing her fiscal deficit from last year’s 9.3% of GDP to 7.3% is looking as though it will be missed and as misery likes friends it will certainly not be improved by higher borrowing costs.
Greece managed to auction some three-month Treasury Bills and even managed to do so at a lower yield than the previous issue but only a small amount of bills were issued and with all the backstops in place and remember we now have guaranteed funding from the ECB until the year-end I am not surprised that there was a rush for what some might consider to be “free money”.