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Strategies & Market Trends : Mish's Global Economic Trend Analysis -- Ignore unavailable to you. Want to Upgrade?

To: mishedlo who wrote (14586)	11/2/2004 10:24:15 AM
From: zonder	Respond to of 116555

US Fed’s Ferguson Signals A Less Aggressive Fed Policy Stance Fed Vice Chairman, Roger Ferguson (who some regard as a likely successor to Greenspan) made an important speech on the neutral interest rate late on Friday (October 28th.) of last week. The implications of his analysis are worth drawing out. Since much commentary on Fed monetary policy simply assumes that the Fed wish to move up to the “neutral” (what Ferguson calls the “equilibrium real interest rate”) rate as soon as possible, it is important to see what the Fed means when it discusses the neutral rate. Many analysts argue that the Fed is embarked on a “gradualist” approach to raising rates. We have a subtly different view. For some time, we have characterised the Fed policy stance as one of “flexible gradualism”. The differences between “gradualism” and “flexible gradualism” are subtle but significant. A “gradualist” approach tends to imply a steady, consistent pace of increase towards a neutral fed funds rate – say implying that the Fed wishes to raise rates by 25bp at every meeting - as they have done over the last three. By contrast, our concept of “flexible gradualism” ties the pace of tightening to the prevailing economic conditions. If the pace of growth (and inflation change) picks up speed, so the Fed can increase the pace of tightening – or if the pace of increase slows, the Fed can reduce the pace of rate increases. We see the Ferguson speech as lending support to our view that the Fed is embarked on a “flexible” path and that the current economic conditions justify slowing the pace of tightening in the near future. Our perspective would imply only one 25bp increase in Fed funds rate (at the November 10th. FOMC) rather than the two consecutive (November + December) moves favoured by some leading US forecasters. Ferguson begins his speech with some observations about how difficult it is to identify any single value for the neutral interest rate. He argues that this varies over time and that current economic conditions in the US economy are compatible with an estimate for the neutral rate, which is below its long-term average. He argues that, “Several aspects of the current outlook lead me to suspect that the return of the equilibrium real rate from its currently depressed level to its long-run value might be plausibly expected to be gradual and attenuated compared with historical experience.” Ferguson mentions three aspects that will make this process gradual and attenuated: 1. “Business Hesitancy” Firstly, he mentions the hesitancy of businesses to invest and to hire labour. “I have already mentioned the role of business hesitancy. Clearly…, that might be one indication that the return of the equilibrium rate to its longer-run level is likely to be relatively gradual.” It is not surprising that Ferguson finds the labour market a source of concern. The recent trend of payrolls growth has been disappointing as we can note from the chart below, nonfarm payrolls growth has averaged 101k per month since June of this year. T he Fed estimates that 150k per month is required simply to match growth in the labour force. Chart One – US Nonfarm Payrolls Growth 2. Fall In the Household Savings Rate Ferguson notes that, “Secondly, the household savings rate has fallen to less than 1% - quite low in its range of historical variation. If households take steps to return the savings rate closer to the middle of that (historical) range, then a sustained period in which consumption grows more slowly than income would result.” Again, it is not too difficult to see Ferguson’s point that a downward correction to consumption is overdue in order to repair personal balance sheets, as a glance at Chart Two will confirm. The savings rate currently stands at 0.4% which is the lowest rate since 1947. Chart Two – Us Savings Rate 3. Fiscal Consolidation The strong likelihood of fiscal consolidation acting as a drag on growth – irrespective of who wins the Presidential election is hinted at by Ferguson. He argues that; “Third, some fiscal restraint is in order, and that one might expect that those who are responsible for fiscal policy will move that policy to a more balanced position, thereby removing some fiscal stimulus. I believe that the combined force of these three factors, restraining aggregate demand, plus others that I have not mentioned, would require a lower real rate than would otherwise be the case.” Conclusion: Implications For Interest Rates The conclusion that Ferguson reaches is as follows. “I believe that it to be very important that the FOMC NOT go on a forced march to some point estimate of the equilibrium real federal funds rate. In my judgement, we should remove the current degree of accommodation at a pace that is importantly determined by incoming data and a changed outlook.” Like many other members of the FOMC, such as Bernanke, Ferguson is reaffirming that the pace of tightening is flexible and that when the economy shows signs of weakness ( as is evident now), the pace of tightening can be slowed. We interpret this to mean that while a November 10th. Rate hike has been effectively priced-in, there is a strong likelihood that there will be a pause taken at the December FOMC unless the economy enjoys a post-election boom.