In this blog post, all emphasis – bold and underlining – are mine.
This overall assessment incorporated the staff’s judgment that vulnerabilities associated with asset valuation pressures, while having come down a little in recent months, nonetheless continued to be elevated.
The staff judged vulnerabilities from financial-sector leverage and maturity and liquidity transformation to be low, vulnerabilities from household leverage as being in the low-to-moderate range, and vulnerabilities from leverage in the nonfinancial business sector as elevated.
The staff also characterized overall vulnerabilities to foreign financial stability as moderate while highlighting specific issues in some foreign economies, including–depending on the country–elevated asset valuation pressures, high private or sovereign debt burdens, and political uncertainties.
Those were from the Staff assessment of financial conditions presented to the Federal Reserve Open Market Committee for its meeting on May 1-2, 2018.
The Federal Reserve staff had begun to characterise the vulnerabilities associated with asset markets price pressures as elevated from July 2017, having upgraded it from ‘moderate’ as noted in the Minutes of the May 2017 meeting of the FOMC. But, this is the first time that they have called vulnerabilities associated with non-financial sector leverage as elevated.
However, when the FOMC participants discussed ‘financial stability’, they did not discuss the possibility that an accommodative monetary policy could cause both asset prices and leverage in the non-financial sector to become more elevated.
Then, there was the use of the word, ‘symmetric’. It figured eleven times in the Minutes of the FOMC meeting of May 11. That is the highest mention in recent meetings. I went all the way back to FOMC meetings in 2016. The word, ‘symmetric’ began to be mentioned in January 2017.
Here is the mention and the context:
The inflation rate over the longer run is primarily determined by monetary policy, and hence the Committee has the ability to specify a longer-run goal for inflation. The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. The Committee would be concerned if inflation were running persistently above or below this objective. Communicating this symmetric inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability and moderate long-term interest rates and enhancing the Committee’s ability to promote maximum employment in the face of significant economic disturbances. [Link]
Then, from the March 2017 FOMC Meeting Minutes:
A few members expressed the view that the Committee should avoid policy actions or communications that might be interpreted as suggesting that the Committee’s 2 percent inflation objective was actually a ceiling. Several members observed that an explicit recognition in the statement that the Committee’s inflation goal was symmetric could help support inflation expectations at a level consistent with that goal, and it was noted that a symmetric inflation objective implied that the Committee would adjust the stance of monetary policy in response to inflation that was either persistently above or persistently below 2 percent. [Link]
The context in which the word, ‘symmetry’ was introduced in the FOMC Minutes is worth recalling. It was introduced in 2017 because the FOMC had decided that it was time to start rising interest rates a little faster than it had done in 2016 and in 2015. In those two years, it had raised them just once each year and that too by 25 bp.
The FOMC had to justify why it was raising them when inflation was not yet at or above 2.0%. So, it came up with the word, ‘symmetric’. That is, it would take action only if was persistently below 2.0% inflation or above it.
Now that inflation is above 2.0%, financial market is expecting that the FOMC might raise rates a bit more rapidly. That expectation is destabilising financial markets or so it is believed. I don’t buy that.
For the record, CPI inflation rate is 2.36%. Core CPI rate is 2.11% and PCE Core Inflation rate is 1.88%.
In order to calm the financial markets, the FOMC is reminding them that it is pursuing a ‘symmetric’ inflation goal. That is, just as it did not refrain from raising rates in 2017 as the inflation rate remained below 2.0% for a few months, it would not necessarily raise the Federal Funds rate more rapidly if inflation stayed above 2.0% for a few months. Only if the overshoot was permanent, would it take action. So, it would go about its task of normalising the monetary policy stance ‘gradually’ rather than ‘rapidly’ or ‘swiftly’.
Personally, I have two problems with this attitude of FOMC:
(1) The Federal Reserve was very very slow to start off the blocks in 2015 and in 2016. After the tapering warning of 2013, it did not raise rates even once in 2014. It raised the rate once in 2015 and in 2016. It was too far behind the curve given the level of the inflation rates then and, more importantly, asset prices.
Corporate profits were contracting y/y for about seven quarters from March 2015 to September 2016. Profit growth was barely above 2% (y/y) in the quarter ending December 2014 and then it turned negative for the next seven quarters. See here.
But, what happened to S&P 500 index? The index barely budged. The S&P 500 index had gone up by more than 20% in 2013, by 10% in 2014 and declined 0.5% in 2015. It was up 19% in 2016 and another 23% in 2017.
The Federal Funds rate, in real terms, remains firmly in the negative territory, even now.
(2) What is the learning from the 2008 crisis, indeed? We all learnt that obsessive focus on inflation without regard to financial stability was the wrong framework for monetary policy. Indeed, this blogger had written on umpteen occasions that in a well-functioning market economy, the central bank did not have to target prices of goods and services. They will regulate themselves. Instead, they should focus on the quantity of money and credit created, on financial stability and hence, by extension, on asset prices. Where is that awareness in the FOMC discussion that features the word, ‘symmetric’ eleven times? What does the FOMC gain by assuaging the sentiment in financial market when, according to its own staff, asset price pressures and leverage in the non-financial sector are ‘elevated’?
Should the FOMC really stick to a gradual removal of policy accommodation with the unemployment rate at 3.9% and with such elevated vulnerabilities associated with prices in asset markets and leverage in the non-financial sector?
It will end up losing, inevitably, whatever extension of the economic cycle it achieves with such ‘gradual’ removal of policy accommodation because when asset prices become more elevated – thanks to the Federal Reserve’s excessive emphasis on ‘symmetry’ – their eventual crash will be bigger with economic consequences that will be both likely more significant and longer lasting.
The 11-times repeat of ‘symmetry’ in the Minutes is indication of panic and obsession with ensuring that financial markets do not push the Treasury bond yield higher. That is because the Federal Reserve transmission mechanism to the real economy is through the financial markets and asset prices (bond and stock prices) or so, it is believed.
The bond market had obliged and the yield on the 10-year Treasury Note had dropped by 13 basis points – from 3.11% to 2.98%. So much for the independent minds of the financial markets and holding policymakers to account. Financial markets are about greed and not about being a check and balance on the errant ways of governments and central banks. They do that only to developing economies.
The Federal budget deficit is rising; debt is rising and yet, the bond market meekly rallies because the Federal Reserve had told them they would be gentle in rising rates! Contrast that with the bond market sell-off in 1994 as the Federal Reserve was raising rates slowly after holding rates at 3.0% for too long. The bond market began to rally only after the Federal Reserve had raised rates by 2.5% and that included a 75 basis point rate hike in October 1994!
Why is the FOMC anxious about the rise in bond yields?
It is because of the amount of debt that has piled up in the economy.
Why has such debt piled up?
It is precisely because of excessive concern for the amount of debt stock every time the FOMC contemplates a rate hike!
The vicious circle continues….