Thursday, June 16, 2005
Greenspeak–Fed is losing influence over markets
Greenspeak–Fed is losing influence over markets
Imbalances pose a risk that the Fed cannot manage
Recent comments by Fed Head Alan Greenspan were a shock because they appear to be an acknowledgement that he, the Fed, is finding that its ability to affect certain markets is diminishing. A big concern because the USA economy is facing major imbalances/bubbles –a budget deficit, a current account deficit, a housing bubble and more.
In speech at the IMF conference on Central Banking (June 6, 2005) the Fed Head noted that the historical relationship between short term rates, which the Fed controls, and long term rates has recently been severed ( http://www.federalreserve.gov/boarddocs/speeches/2005/20050606/default.htm ) :
"The pronounced decline in U.S. Treasury long-term interest rates over the past year despite a 200-basis-point increase in our federal funds rate is clearly without recent precedent. The yield on ten-year Treasury notes currently is at about 4 percent, 80 basis points less than its level of a year ago. Moreover, despite the recent backup in credit risk spreads, yields for both investment-grade and less-than-investment-grade corporate bonds have declined even more than Treasuries over the same period."
It should be noted that Oscar Yorda visiting scholar at the San Francisco Fed recently ( May 20, 2005) argued in the San Fran’s Economic letter; "that the Fed does influence long-term rates significantly." ( http://www.frbsf.org/publications/economics/letter/2005/el2005-09.html )
In his testimony before Congress, on June 9, 2005 Greenspan reiterated his concern over the diminished ability of short term rates to influence long term rates. The Fed Head then went on to note how this anomaly in long term yields was contributing to the housing bubble.
(http://www.federalreserve.gov/boarddocs/testimony/2005/200506092/default.htm):
"That said, there can be little doubt that exceptionally low interest rates on ten-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of homebuilding and home turnover, and especially in the steep climb in home prices. Although a "bubble" in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels."
Taken together Greenspan is saying that low long term rates (ten year yields) were helping fuel the housing bubble. That the Fed’s historical ability to influence long term rates through its primary policy tool of short term rates was not working. A steep rise in short term rates by the Fed has had no influence on long yields. In conclusion, to date the Fed has had no success in cooling the red hot housing market.
A host of arguments could be put forth against this conclusion, from questioning how much influence does the Fed really have on housing, to lower long rates are a function of lowered inflation expectations based upon the Fed’s aggressive policy of rate rises to snuff out inflation.
But the fact remains that in the face of aggressive rate rises by the Fed the housing market has and continues to rise.
To this Fed watcher this presents an unusual dilemma for Greenspan. We have a housing bubble and imbalances in several sectors of the economy as Greenspan himself admits, and the Fed finds that its policies are ineffectual?
The New York Times (‘Fed Chief Sees ‘Reasonably Firm’ Economy With Imbalances, June 9, 2005 by Edmund L. Andrews) noted that Greenspan admitted that there were imbalances and challenges ahead in his June 9, 2005 testimony to Congress:
"Today, Mr. Greenspan appeared to pay homage to those who have worried about the rising levels of debt and speculative behavior that are in part a result of the Fed's decision to slash interest rates from 2001 through June 2004."
Historically it has been the adroit moves by the Maestro himself to divert disaster through his policies and antics that have been his hallmark. When a crisis hit there was a solution. Whether it be the flood of liquidity after the 1987 stock market crash or with our most recent recession, to jawboning participants with the failure of Long Term Capital Management, to exploiting some wrinkle in the law as done with the Mexican crisis of 1994/95--Greenspan always found a way out of the mess.
Free marketeers may argue that this is all much ado about nothing. That more rate hikes are needed and that they will ultimately do their job. The Fed is still in control. Others such as myself would say that almost two decades of profligate policies under Greenspan are having their cumulative affect.
The chickens are coming home to roost and the Fed Head finds his ability to influence markets is waning. And he knows it!
Imbalances pose a risk that the Fed cannot manage
Recent comments by Fed Head Alan Greenspan were a shock because they appear to be an acknowledgement that he, the Fed, is finding that its ability to affect certain markets is diminishing. A big concern because the USA economy is facing major imbalances/bubbles –a budget deficit, a current account deficit, a housing bubble and more.
In speech at the IMF conference on Central Banking (June 6, 2005) the Fed Head noted that the historical relationship between short term rates, which the Fed controls, and long term rates has recently been severed ( http://www.federalreserve.gov/boarddocs/speeches/2005/20050606/default.htm ) :
"The pronounced decline in U.S. Treasury long-term interest rates over the past year despite a 200-basis-point increase in our federal funds rate is clearly without recent precedent. The yield on ten-year Treasury notes currently is at about 4 percent, 80 basis points less than its level of a year ago. Moreover, despite the recent backup in credit risk spreads, yields for both investment-grade and less-than-investment-grade corporate bonds have declined even more than Treasuries over the same period."
It should be noted that Oscar Yorda visiting scholar at the San Francisco Fed recently ( May 20, 2005) argued in the San Fran’s Economic letter; "that the Fed does influence long-term rates significantly." ( http://www.frbsf.org/publications/economics/letter/2005/el2005-09.html )
In his testimony before Congress, on June 9, 2005 Greenspan reiterated his concern over the diminished ability of short term rates to influence long term rates. The Fed Head then went on to note how this anomaly in long term yields was contributing to the housing bubble.
(http://www.federalreserve.gov/boarddocs/testimony/2005/200506092/default.htm):
"That said, there can be little doubt that exceptionally low interest rates on ten-year Treasury notes, and hence on home mortgages, have been a major factor in the recent surge of homebuilding and home turnover, and especially in the steep climb in home prices. Although a "bubble" in home prices for the nation as a whole does not appear likely, there do appear to be, at a minimum, signs of froth in some local markets where home prices seem to have risen to unsustainable levels."
Taken together Greenspan is saying that low long term rates (ten year yields) were helping fuel the housing bubble. That the Fed’s historical ability to influence long term rates through its primary policy tool of short term rates was not working. A steep rise in short term rates by the Fed has had no influence on long yields. In conclusion, to date the Fed has had no success in cooling the red hot housing market.
A host of arguments could be put forth against this conclusion, from questioning how much influence does the Fed really have on housing, to lower long rates are a function of lowered inflation expectations based upon the Fed’s aggressive policy of rate rises to snuff out inflation.
But the fact remains that in the face of aggressive rate rises by the Fed the housing market has and continues to rise.
To this Fed watcher this presents an unusual dilemma for Greenspan. We have a housing bubble and imbalances in several sectors of the economy as Greenspan himself admits, and the Fed finds that its policies are ineffectual?
The New York Times (‘Fed Chief Sees ‘Reasonably Firm’ Economy With Imbalances, June 9, 2005 by Edmund L. Andrews) noted that Greenspan admitted that there were imbalances and challenges ahead in his June 9, 2005 testimony to Congress:
"Today, Mr. Greenspan appeared to pay homage to those who have worried about the rising levels of debt and speculative behavior that are in part a result of the Fed's decision to slash interest rates from 2001 through June 2004."
Historically it has been the adroit moves by the Maestro himself to divert disaster through his policies and antics that have been his hallmark. When a crisis hit there was a solution. Whether it be the flood of liquidity after the 1987 stock market crash or with our most recent recession, to jawboning participants with the failure of Long Term Capital Management, to exploiting some wrinkle in the law as done with the Mexican crisis of 1994/95--Greenspan always found a way out of the mess.
Free marketeers may argue that this is all much ado about nothing. That more rate hikes are needed and that they will ultimately do their job. The Fed is still in control. Others such as myself would say that almost two decades of profligate policies under Greenspan are having their cumulative affect.
The chickens are coming home to roost and the Fed Head finds his ability to influence markets is waning. And he knows it!
