Last week’s minutes from the FOMC’s January meeting showed divided opinion on the effectiveness of QE and how much longer it should be employed for.
But reading between the lines we can get a clearer view as to why the minutes drew attention to the split and what the resulting policy going forward may be.
Why the attention on the costs of QE?
Esther George, president of the Federal Reserve Bank of Kansas City, voted against continuing asset purchases at the central bank’s January meeting out of concern about “the risks of future economic and financial imbalances,” according to the minutes. Prices “of assets such as bonds, agricultural land, and high-yield and leveraged loans are at historically high levels.”
Farmland in the Midwest was up 16% in 2012 (Iowa saw prices rise 20%), according to the Federal Reserve of Chicago, the third largest annual gain since the 1970’s.
Fed Governor Jeremy Stein is concerned with corporate debt as yields reach record lows, driven ever lower by investors seeking any form of yield. Equity markets have seen a significant rise, the S&P 500 is up almost 40% since October 2011, raising questions as to who is benefiting the most from the Fed’s ultra-loose monetary policy.
So what is the message between the lines?
In 2010 Janet Yellen was asked to chair a new FOMC communications subcommittee to focus on central bank transparency to minimise confusion over Fed policy.
But its purpose extends far beyond that of providing markets with a transparent message. Instead, it has allowed the Fed to utilize communication as a further tool;
Communicating that certain members are concerned by specific financial imbalances enables the Fed to highlight that it is aware of these imbalances and can act if it needs to. Emphasising this concern can, they hope, dampen excessive speculation in certain areas without affecting the overall policy objective of maximising employment while maintain price stability.
Unemployment remains persistently high. The Bureau of Labor Statistics U6 unemployment figure, which unlike the reported unemployment number (U3), includes discouraged workers and those who would like to work, either full-time or part-time, but cannot due to economic reasons, is at 14.4% – some 40% above the long term average (see chart).
Inflationary expectation remain subdued. The attached chart, published in The Economist, shows that 10 year breakeven rates remain low, although Japan has seen a meaningful rise since 2011.
(Source: The Economist)
The message remains clear: until proof begins to emerge that economic figures truly reflect an improvement in the economy we will see very little change from Fed policy. Unless you believe that the fed’s communication tool can effectively dampen asset price bubbles, risk assets have some way still to go.