Pundits Digesting Nuances of Signals from the Fed, Bank of Japan and ECB

August 31, 2010

Among the most telling comments in the August FOMC minutes is the sentence, “Members generally saw both employment and inflation as likely to fall short of levels consistent with the dual mandate for longer than had been anticipated.” Often with a mandate to maintain price stability but also maximize jobs, there is a conflict with one goal suggesting a tighter stance and the other arguing for less restraint.  That is not the case now, and circumstances on both criteria were warranting more accommodation when officials met in August than what they observed in late June.  Not to have made any change this month could only have been justified if officials concluded that every conceivable action on its part would create greater cost than stimulus.  That was not the case; however, officials stopped short at only blocking some passive tightening that was to have occurred under the pre-existing policy.  Tom Hoenig’s sole dissent in favor of a less accommodative stance makes the same objection as similar dissents he made at the four prior meetings, only its justification has become less defensible and thus is now of marginal importance and basically irrelevant.

Another point that caught my attention in the FOMC minutes is that with greater slack in the economy now than assumed in June and less growth projected than before in 2H10, officials reach the inescapable conclusion that an “elevated” excess in resources of production will remain even at the end of 2011 sixteen months from now.  And the final thought from the minutes that bears repeating is the idea that while disinflation and not deflation is by far the likeliest outlook, the economy is disproportionately vulnerable to any “further adverse shocks.”  Unless information occurs soon that paints U.S. growth and price pressure in a better light, further easing seems quite plausible in if not before January.

Japanese politics is in disarray.  Not that such is unusual in this land of revolving door leadership, but this is no time for a fresh crisis.  The financial press gave yesterday’s unscheduled expansion of low-cost credit a double-whammy boo-how, with the FT even complaining about the over-use of ad-hoc meetings.  As in the Fed’s case, the Bank of Japan Policy Board opted for a mild gesture from an arsenal of choices that includes much tougher and more selective medicine to address the main drags on growth and prices.  Most important, markets concurred with analysts, sending the Nikkei down 3.6%, 10-year JGB yields to 0.97% from 1.03%, and the yen as high as 83.82 per dollar and 106.17 versus the euro.  The BOJ did the same thing as last March, only expanding the facility less dramatically this time than then.  That action didn’t boost growth and lending, nor did it stymie the appreciation of the yen, which is the greatest threat to the recovery.  With no fiscal calvary, the Bank of Japan has got to generate some real shock-and-awe.  Currency intervention should have been tried already when there would have been a greater element of surprise, but this is a case of better-late-than-never.

The ECB has sent two messages even as it became mired in an untimely distraction.  One of these is that while shortening the amount and  maturity of excess liquidity in the marketplace, short-term injections will likely continue through year-end.  The other was packaged in President Trichet’s ringing endorsement of fiscal cutbacks to be taken in a daring way and with dispatch.  That subjective stance contrasts with Fed Chairman Bernanke’s minimal and indirect references to fiscal policy, which implied that a continuing appropriate role exists for some continuing U.S. fiscal support because monetary policy alone is not equipped to nurse the economy back to full health.  Finally, Thilo Sarrazin, the Bundesbanker from Berlin whose controversial remarks in a book have created quite a stir in the news.  A vigil is on to see if he will be dumped or not and how much damage to the ECB presidential prospects of Bundesbank President Weber, who wants Trichet’s job starting in October 2011.  This red herring has no immediate policy implication.  Sarrazin has no role at the ECB, and Weber currently is but one voice on a committee of 22, the so-called ECB Governing Council that decides the monetary policy in Euroland.

The thrust of these varied signals is that 1) the yen is likely to keep grinding higher unless or until FX intervention is deployed and 2) the contribution of Fed and ECB policy to near-term currency market swings should favor the euro against the dollar.  That doesn’t necessarily mean that the euro’s rebound since early June will be extended much further because there are other independent variables in the equation. 

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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