Federal Funds Rate

Janet Yellen will keep driving up the Sensex

yellen_janet_040512_8x10Vivek Kaul

The Bombay Stock Exchange (BSE) Sensex, India’s premier stock market index, rose by 517.22 points or 1.88% to close at 27,975.86 points yesterday (i.e. March 30, 2015). On March 27, 2015 (i.e. Friday), Janet Yellen, the Chairperson of the Federal Reserve of the United States, gave a speech (after the stock market in India had closed). In this speech she said: “If conditions do evolve in the manner that most of my FOMC colleagues and I anticipate, I would expect the level of the federal funds rate to be normalized only gradually, reflecting the gradual diminution of headwinds from the financial crisis.” The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans. What Yellen was basically saying is that even if the Federal Reserve starts raising interest rates, it will do so at a very slow pace. In the aftermath of the financial crisis that started in mid September 2008, when the investment bank Lehman Brothers went bust, central banks in the developing countries have maintained very low rates of interest. The Federal Reserve of the United States, the American central bank , has been leading the way, by maintaining the federal funds rate in the range of 0-0.25%. The hope was that at low interest rates people would borrow and spend more than they were doing at that point of time. This would help businesses grow and in turn help the moribund economies of the developing countries. While people did borrow and spend to some extent, a lot of money was borrowed at low interest rates in the United States and other developed countries where central banks had cut rates, and it found its way into stock markets and other financial markets all over the world. This led to a massive rallies in prices of financial assets. For the rallies in financial markets all over the world to continue, the era of “easy money” initiated by the Federal Reserve needs to continue. And this is precisely what Yellen indicated in her speech yesterday. She said that even if the Fed starts to raise interest rates it would do so at a very slow pace, in order to ensure that it does not end up jeopardizing the expected economic recovery. Yellen went on to add in her speech on Friday that: “Nothing about the course of the Committee’s actions is predetermined except the Committee’s commitment to promote our dual mandate of maximum employment and price stability.” This is where things get interesting. The rate of unemployment in the United States in February 2015 was at 5.5%. This was a significant improvement over February 2014, when the rate of unemployment was at 6.7%. But even with this big fall, the Federal Reserve is unlikely to raise interest rates. Typically, as unemployment falls, wages go up, as employers compete for employees. But that hasn’t happened in the United States. The wage growth has been more or less flat over the last one year (it’s up by 0.1%). The major reason for the same is that more and more jobs are being created at the lower end. As economist John Mauldin writes in his newsletter: “66,000 of the 295,000 new jobs[that were created in February 2015) were in leisure and hospitality, with 58,000 of those being in bars and restaurants…Transportation and warehousing rose by 19,000, but 12,000 of those were messengers, again not exactly high-paying jobs.” Further, in the last few years the energy industry in the United States has seen a big boom on the back of the discovery of shale oil. But with oil prices crashing, the energy industry has started to shed jobs. In January 2015, the energy industry fired 20, 193 individuals. This was 42% higher than the total number of people who were sacked in 2014. As analyst Toni Sangami pointed out in a recent post: “These oil jobs are among some of the highest-paying blue-collar jobs in the country, so losing one oil job is like losing five or eight or ten hospitality-industry jobs.” The labour force participation ratio, which is a measure of the proportion of the working age population in the labour force, in February 2015 was at 62.8%. It has more or less stayed constant from December 2013, when it was at 62.8%. This is the lowest it has been since March 1978. The number was at 66% in December 2007. What this means is that the rate of unemployment has been falling also because of people opting out of the workforce because they haven’t been able to find jobs and, hence, were no longer being counted as unemployed. So, things are nowhere as fine as broader numbers make them appear to be. The overall inflation also remains much lower than the Federal Reserve’s target of 2%. The Federal Reserve’s preferred measure of inflation is personal consumption expenditures(PCE) deflator, ex food and energy. For the month of February 2015, this number was at 1.4% much below the Fed’s target of 2%. The Fed’s forecast for inflation for 2015 is between 0.6% to 0.8%. At such low inflation levels, the interest rates cannot be raised. Yellen summarized the entire situation beautifully when she told the Senate Banking Committee earlier this month that: “Too many Americans remain unemployed or underemployed, wage growth is still sluggish, and inflation remains well below our longer-run objective.” What does not help is the weak durables data that has been coming in. Orders for durable goods or long-lasting manufactured goods from automobiles to aircrafts to machinery, fell by 1.4% in February 2015. The durables data have declined in three out of the last four months. Given this scenario, it is highly unlikely that the Yellen led Federal Reserve will start raising the federal funds rate any time soon. Further, as and when it does start raising rates, it will do so at a very slow pace. What this means is that the era of easy money will continue in the time to come. And given this, more acche din are about to come for the Sensex. Having said that, any escalation of conflict in the Middle East can briefly spoil this party. The article originally appeared on The Daily Reckoning on Mar 31, 2015

Coming up: The $9 trillion problem of global finance

3D chrome Dollar symbolThat global finance has been in a mess since the start of the global financial crisis in September 2008, is old news now. But the fact that a bigger mess might be awaiting it, should still make for news.
A January 2015 research paper titled Global dollar credit: links to US monetary policy and leverage authored by Robert N McCauley, Patrick McGuire and Vladyslav Sushko who belong to the Monetary and Economic Department at the Bank for International Settlements (BIS), has been doing the rounds in the recent past.
As per this paper : “Since the global financial crisis, banks and bond investors have increased the outstanding US dollar credit to non-bank borrowers outside the United States from $6 trillion to $9 trillion.” In 2000, the number had stood at $2 trillion.
What this clearly tells us is that over the years there has been a huge jump in the total amount of borrowing that has happened in dollars, outside the United States. Hence, more and more foreigners(to the United States) have been borrowing in dollars.
A similar trend has not be seen in case of other major currencies like the euro and the yen. In case of the euro the number stands at $2.5 trillion. For the yen, the number is at just $0.6 trillion. “Moreover, euro credit is quite concentrated in the euro area’s neighbours,” the BIS report points out. Hence, a major part of the world continues to borrow in dollars.
The question is which countries have borrowed all this money that has been lent? As the BIS report points out: “Dollar credit to Brazilian, Chinese and Indian borrowers has grown rapidly since the global financial crisis…Dollar borrowing has reached more than $300 billion in Brazil, $1.1 trillion in China, and $125 billion in India. The rapid growth of bonds relative to loans is more evident in Brazil and India than in China.”
This is happening primarily because domestic interest rates in these countries are on the higher side in comparison to the interest rates being charged on borrowing in dollars. Further, in the aftermath of the financial crisis, the Federal Reserve of the United States, initiated a huge money printing programme and at the same time decided to maintain the federal funds rate between 0-0.25%. This led to more and more borrowers deciding to borrow in US dollars.
“A low level of the federal funds rate…is associated with higher growth of dollar loans to borrowers outside the US…A 1 percentage point widening in a country’s policy rate relative to the federal funds rate is, on average, associated with 0.03% more dollar bank loans relative to GDP in the following quarter ,” the BIS paper points out. And that explains the rapid expansion of dollar loans.
The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans.
Interestingly, countries which are referred to as emerging market countries have borrowed close to $4.5 trillion of the total $9 trillion. “The emerging market share – mostly Asian – has doubled to $4.5 trillion since the Lehman crisis, including camouflaged lending through banks registered in London, Zurich or the Cayman Islands,” points out Ambrose Evans-Pritchard in a recent piece in The Telegraph.
So what are the implications of this? First and foremost the world is now more closely connected to the monetary policy practised by the Federal Reserve of the United States. As the BIS paper points out: “Changes in the short-term policy rate are promptly reflected in the cost of $5 trillion in US dollar bank loans.” What this basically means is that if the Federal Reserve chooses to raise the federal funds rate any time in the future, the interest that needs to be paid on the dollar debt will also go up. And with the huge amount of money that has been borrowed, this could precipitate the next level of the crisis, if the borrowers are unable to pay up on the higher interest. One of the dangers that can arise is “if borrowers need to substitute domestic debt for dollar debt in adverse circumstances, then the exchange rate would come under pressure.”
There are other risks as well that need to be highlighted. There is a growing concern that companies in emerging markets have borrowed in dollars to essentially fund carry trades, where they are borrowing in dollars at low interest rates and then lending out that money at higher interest rates in their own country. Hence, nothing constructive is happening with the money that is being borrowed. It is simply being used for speculation.
Many of the companies borrowing in dollars are essentially borrowing for the first time in dollars. And this leads to the question whether the lenders have carried out an adequate amount of due diligence. Further, some of this borrowing may not have been captured in domestic debt statistics of countries. This means that countries may have actually borrowed more than their numbers suggest. Hence, when the time comes to repay this can put pressure on foreign exchange reserves. Lastly, with firms borrowing in dollars, the domestic policy-makers like central banks and finance ministries, may be misled “by the slower pace of domestic bank credit expansion”. This could mean lower interest rates when they should actually be raised. Lower interest rates can lead to more asset bubbles in financial markets.
What is not helping the cause is the fact that the dollar has appreciated rapidly against other major currencies. It has appreciated by around 25% since June 2014 against other major currencies. This means in order to repay the dollar loans or even to pay interest on it, the borrowers need a greater amount of local currency to buy dollars.
To conclude, it is worth repeating what I often say: before things get better, they might just get worse. Keep watching.

(Vivek Kaul is the author of Easy Money. He tweets @kaul_vivek)

The column originally appeared on Firstpost on Mar 25, 2015 

Janet Yellen’s excuses for not raising interest rates will keep coming

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The Federal Open Market Committee(FOMC) of the Federal Reserve of the United States, which is mandated to decide on the federal funds rate, met on March 17-18, 2015.
The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans.
In the meeting the FOMC decided to keep the federal funds rate in the range of 0-0.25%, as has been in the case in the aftermath of the financial crisis which broke out in September 2008. Janet Yellen, the chairperson of the Federal Reserve also clarified that “an increase in the target range for the federal funds rate remains unlikely at our next meeting in April.” The next meeting of the FOMC is scheduled on April 27-28, 2015.
The question is when will the Federal Reserve start raising the federal funds rate? As the FOMC statement released on March 18 points out: “In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 % inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments.”
Other than a clear inflation target of 2%, this is as vague as it can get. The inflation number in January 2015 came in at 1.3%, well below the Fed’s 2% target. The Fed’s forecast for inflation for 2015 is between 0.6% to 0.8%. At such low inflation levels, the interest rates cannot be raised.
But the Federal Reserve wasn’t as vague in the past as it is now. In December 2012, the Federal Reserve decided to follow the Evans rule (named after Charles Evans, who is the President of the Federal Reserve Bank of Chicago and also a part of the FOMC). As per the Evans rule, the Federal Reserve would keep interest rates low till the rate of unemployment fell below 6.5 % or the rate of inflation went above 2.5 %.
As the FOMC statement released on December 12, 2012 said: “ the Committee decided to keep the target range for the federal funds rate at 0 to 1/4 % and currently anticipates that this exceptionally low range for the federal funds rate will be appropriate at least as long as the unemployment rate remains above 6.5%, inflation between one and two years ahead is projected to be no more than a half percentage point above the Committee’s 2% longer-run goal, and longer-term inflation expectations continue to be well anchored.”
This is how things continued until March 2014, when the Federal Reserve dropped the Evans rule. In a statement released on March 19, 2014, one year back, the FOMC said: “In determining how long to maintain the current 0 to 1/4 % target range for the federal funds rate, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 % inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments.” In fact, this is exactly the wording the FOMC has used in the statement released on March 18, 2015.
What the FOMC meant in the March 2014 statement was that instead of just looking at the rate of unemployment and the rate of inflation, the Federal Reserve would also take into account other factors before deciding to raise the federal funds rate. So what made the Federal Reserve junk the Evans rule?
In February 2014, the rate of unemployment was at 6.7% and was closing in on the Evans rule target of 6.5%. In April 2014, the rate of unemployment had fallen to 6.2%.
If the Fed would have still been following the Evans rule, it would have to start raising the Federal Funds rate. This would have meant jeopardising the stock market rally which has been on in the United States. In the aftermath of the financial crisis, the Federal Reserve had cut the federal funds rate to 0-0.25%, in the hope of encouraging people to borrow and spend more, to get their moribund economies going again.
While people did borrow and spend to some extent, a lot of money was borrowed at low interest rates in the United States and other developed countries where central banks had cut rates, and it found its way into stock markets and other financial markets all over the world. This led to a massive rallies in prices of financial assets. In an era of close to zero interest rates the stock market in the United States has seen the longest bull market after the Second World War.
Any increase in the federal funds rate would jeopardise the stock market rally. And that is something that the American economy can ill-afford to. So, it is in the interest of the Federal Reserve to just let the stock market rally on.
Interestingly, the Federal Reserve has been changing the so-called “forward guidance” on raising the federal funds rate for a while now. In March 2009, it had said that short-term interest rates will stay low for an “extended period.” In August 2011, it said that short-term interest rates would stay low till “mid-2013.” In January 2012, the Fed said that short-term interest rates would remain low till “late 2014.” And by September 2012, this had gone up to “mid-2015.”
In March 2014, it junked the Evans rule. So, what this means is that the Federal Reserve will ensure that interest rates in the United States continue to stay low. Peter Schiff, the Chief Executive of Euro Pacific Capital, summarized the situation best when he said that the Federal Reserve would “keep manufacturing excuses as to why rates cannot be raised” and this was simply because it had “built an economy completely dependent on zero % interest rates.”
Given this, be prepared for Janet Yellen offering more excuses for not raising the federal funds rate in the days to come.

The column originally appeared on The Daily Reckoning on Mar 20, 2015

Janet Yellen is not going to takeaway the punchbowl any time soon

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Central banks are primarily in the business of sending out messages to the financial markets. In a statement released on January 28, 2015, the Federal Reserve of the United States had said: “Based on its current assessment, the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.”
In simple English what this means is that the Fed would be patient when it comes to increasing the federal funds rate, which in the aftermath of the financial crisis which started in September 2008, has been in the range of 0-0.25%. The federal funds rate is the interest rate at which one bank lends funds maintained at the Federal Reserve to another bank on an overnight basis. It acts as a sort of a benchmark for the interest rates that banks charge on their short and medium term loans. This is the longest period for which the rate has remained at such low levels, in over fifty years.
In the aftermath of the financial crisis, the Federal Reserve and other central banks around the world had cut interest rates to very low levels in the hope of encouraging people to borrow and spend more, to get their moribund economies going again.
While people did borrow and spend to some extent, a lot of money was borrowed at low interest rates in the United States and other developed countries where central banks had cut rates, and it found its way into stock markets and other financial markets all over the world. This led to a massive rallies in prices of financial assets. In an era of close to zero interest rates the stock market in the United States has seen the longest bull market after the Second World War.
Given this, the stock markets in the United States and in other parts of the world have been doing well primarily because of this low interest rate scenario that prevails. With the return available from fixed income investments(like bonds and bank deposits) down to very low levels, money has found its way into the stock market.
The January 28 statement was released after a meeting of the Federal Open Market Committee(FOMC) which is mandated to decide on the federal funds rate. These meetings of the FOMC are followed very closely all over the world simply because if the Federal Reserve does decide to start raising the federal funds rate or even give a hint of it, stock markets all over the world will fall.
After the January meeting, the FOMC met again on March 17-18, 2015. In a statement that the Federal Reserve released yesterday (i.e. March 18) after the FOMC meeting, it had dropped the word “patient”. So does this mean that the Federal Reserve will start to be “impatient” when it comes to the federal funds rate?
The Federal Reserve chairperson Janet Yellen held a press conference yesterday after the two day meeting of the FOMC, in which she clarified that: “Modification of our guidance should not be interpreted to mean that we have decided on the timing of that increase. In other words, just because we removed the word “patient” from the statement doesn’t mean we are going to be impatient.”
So what Yellen was essentially saying is that even though the Fed had removed the word “patient” from its statement released yesterday, it was not going to be “impatient,” when it comes to increasing the federal funds rate in particular and interest rates in general. Welcome to the world of central bank speak.
In fact, Yellen also clarified that the FOMC won’t increase the federal funds rate when it meets next towards the end of April, next month. At the same time she said there was a chance that the FOMC might raise the federal funds rate in the meetings after April.
This statement of Yellen has led to the conclusion in certain sections of the media that the Federal Reserve will start raising interest rates June onwards, when it meets next after the April meeting. Only if things were as simple as that. Chances of the FOMC raising interest rates this year are remote. There are multiple reasons for the same.
First and foremost is the fact that inflation in the United States is well below the Federal Reserve’s preferred target of 2%. In fact, for the month of January 2015, this number was at 1.3% much below the Fed’s target of 2%. The Fed’s forecast for inflation for 2015 is between 0.6% to 0.8%. At such low inflation levels, the interest rates cannot be raised.
Inflation is down primarily because of low oil prices as well as the fact that the dollar has rallied (i.e. appreciated) against other major currencies of the world, in the process making imports cheaper for the people of United States. Lower import prices have a significant impact on inflation. The dollar has gone up in value against the yen and the euro primarily because of the money being printed by the Bank of Japan and the European Central bank. This money printing is not going to stop any time soon. As more money is printed and pumped into the financial system, interest rates are likely to remain low. At low interest rates the hope is that people will borrow and spend more and this will benefit businesses and the overall economy.
Getting back to the dollar, an appreciating currency has the same impact on the economy as higher interest rates. Higher interest rates are supposed to slowdown demand and in the process economic growth. Along similar lines when a currency appreciates, the exports of the country become expensive and this leads to a fall in exports. This slows down economic growth. Hence, in a way an appreciating dollar has already done a part of what the Fed would have done by raising interest rates.
With a lot of money printing happening in other parts of the world, chances are the dollar will continue to appreciate. Also, oil prices are likely to remain low during the course of this year, meaning low inflation in the US.
Further in December 2014, the Fed had forecast that economic growth in the US in 2015 will range between 2.6% to 3%. This has been slashed to 2.3% to 2.7%. In this scenario , it doesn’t seem likely that the Federal Reserve will raise the federal funds rate any time soon (may be not during the course of 2015).
William McChesney Martin, the longest serving Federal Reserve Chairman, once said that the job of the Fed is “to take away the punch bowl just as the party gets going.” Yellen as of now doesn’t want to spoil the party. What this means is that the stock market rallies in large parts of the world are likely to continue in the days to come.
The only thing one can say at this point of time is—Stay tuned!

(Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)

The article originally appeared on www.firstpost.com on Mar 19,2015

Fed may be reducing easy money, but here’s why Sensex will keep soaring

yellen_janet_040512_8x10Vivek Kaul

In theory there is no difference between theory and practice. In practice there is.

– Yogi Berra

A question I am often asked is why are the stock markets around the world still rallying despite the Federal Reserve of United States going slow on printing money. In a statement released yesterday the Fed decided to cut down further on money printing.
It will now print $15 billion per month instead of the earlier $25 billion. This was the seventh consecutive cut of $10 billion. Since December 2012, the Federal Reserve had been printing $85 billion per month. This money was pumped into the financial system by buying mortgage backed securities and government bonds. The idea was that by increasing the amount of money in the financial system, long term interest rates could be driven lower. The hope was that at lower interest rates, people would borrow and spend more.
From January 2014, the Federal Reserve decided to buy bonds worth $75 billion a month, instead of the earlier $85 billion. This meant that the Fed would be printing $75 billion a month instead of the earlier $85 billion. This cut in money printing came to be referred to as “tapering”, which means getting progressively smaller. Since then the amount of money being printed by the Federal Reserve has been tapered to $15 billion per month. At this pace the Federal Reserve should be done at dusted with its money printing by next month i.e. October 2014.
A lot of this printed money instead of being lent out to consumers has found its way around into stock markets and other financial markets around the world. The Dow Jones Industrial Average, America’s premier stock market index, has rallied more than 30% since October, 2012. This when the American economy hasn’t been in the best of shape.
The FTSE 100, the premier stock market index in the United Kindgom, has given a return of 15% during the same period. The Nikkei 225, the premier stock market index of Japan has rallied by 53% during the same period. Closer to home, the BSE Sensex has rallied by around 43% during the same period.
Stock markets around the world have given fabulous returns, despite the global economy being down in the dumps. The era of easy money unleashed by the Federal Reserve has obviously helped.
Nevertheless, the question is with the Fed clearly signalling that the easy money era is now coming to an end, why are stock markets still holding strong? One reason is the fact that even though the Fed might be winding down its money market operations, other central banks are still continuing with it.
The Bank of Japan, the Japanese central bank is printing around ¥5-trillion per month and is expected to do so till March 2015. The European Central Bank is also preparing to print €500-billion to €1-trillion over the next few years. What this means is that interest rates in large parts of the Western world will continue to remain low. Hence, big institutional investors can borrow from these financial markets and invest the money in stock markets around the world.
The second and more important reason is that the Federal Reserve does not plan to shrink its balance sheet any time soon. Before the financial crisis started in September 2008, the size of the Federal Reserve balance sheet stood at $925.7 billion. Since then it has ballooned and as on August 27, 2014, it stood at $4.42 trillion.
The size of the Fed balance sheet has exploded by close to 378% over the last six years. This has happened primarily because the Fed has printed money and pumped it into the financial system by buying bonds, in the hope of keeping interest rates low and getting people to borrow and spend.
Janet Yellen, the current Chairperson of the Federal Reserve made it very clear yesterday that the Fed was in no hurry to withdraw this money from the financial system. It could take to the “end of the decade” to shrink the Fed’s huge balance sheet “to the lowest levels consistent with the efficient and effective implementation of policy.”
What this essentially means is that the money that the Fed has printed and pumped into the financial system by buying bonds, will not be suddenly withdrawn from the financial system. When a bond matures, the institution which has issued the bond, repays the money invested to the institution that has invested in it.
If the investor happens to be the Federal Reserve, the maturing proceeds are paid to it. This leads to the amount of money in the financial system going down, and could lead to interest rates going up, as money becomes dearer.
This is something that the Fed does not want, in order to ensure that individuals continue borrow and spend money, and this, in turn, leads to economic growth. Hence, the Fed will use the money that comes back to on maturity, to buy more bonds and in that way ensure that total amount of money floating in the financial system does not go down.
This means that long term interest rates will continue to remain low. Hence, investors can continue to borrow money at low interest rates and invest that money in different parts of the world.
Yellen also clarified that short-term interest rates are also not going to go up any time soon. As she said “economic conditions may for some time warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.”The federal funds rate is the interest rate that banks charge each other to borrow funds overnight, in order to maintain their reserve requirement at the Federal Reserve. This interest rate acts as a benchmark for short-term loans.
Given these reasons, the stock markets around the world will continue to rally, at least in the near term, as the era of easy money will continue. These rallies will happen, despite global growth being down in the dumps and the fact that the global economy is still to recover from the financial crisis that started just about six years and three days back, when the investment bank Lehman Brothers went bust on September 15, 2008.
To conclude, Ben Hunt who writes the Epsilon Theory newsletter put it best in a recent newsletter dated September 8, 2014, and titled The Ministry of Markets: “No one doubts the omnipotence of central banks. No one doubts that market outcomes are fully determined by central bank policy. No one doubts that central banks are large and in charge. No one doubts that central banks can and will inflate financial asset prices. And everyone hates it.”
The article appeared originally on www.FirstBiz.com on Sep 18, 2014

 (Vivek Kaul is the author of the Easy Money trilogy. He tweets @kaul_vivek)