Tag Archives: interest rate policy

February Employment Report: Implications for Monetary Policy

During her inaugural public appearance since becoming chairwoman, Janet Yellen confirmed that her intention is to continue the policies of her predecessor Ben Bernanke. As the economy improves, Yellen intends to slowly wind down the large-scale asset purchases – also referred to as quantitative easing (QE). I believe the February employment report provides data to confirm this plan, however, constructing forward guidance will still be a challenge.

The February employment report was released on Friday, March 7th and showed positive signs about the economic recovery. According to the Wall Street Journal, “Nonfarm payrolls grew by a seasonally adjusted 175,000 in February, the Labor Department said Friday, following a two month stretch of weaker growth. The unemployment rate ticked up to 6.7%, in part because more people joined the workforce”. Although the unemployment rate increased, it increased for all the right reasons. In this case, the rise in the unemployment rate reflects a rise in the labor force participation rate – a sign that conditions are improving in the labor market. As sentiment about the labor market improves, people are choosing to return to the labor force and pursue jobs. In addition, the increase 175,000 jobs added beat expectations and was more than the previous month – indicating that adverse weather likely depressed previous employment reports this winter. I speculate that the strong February employment report will encourage the Federal Reserve (Fed) to continue tapering.

I believe the Fed might find this an opportune time to adjust forward guidance, but I am not sure how they will do it. According to the Wall Street Journal, “A more vexing challenge for the Fed will be fine-tuning its official policy statement, which is loaded with assurances of low-interest rates in the future”. With the exception of the February employment report, the unemployment rate has been falling consistently. The Fed has already stated that it intends to keep rates low even after the unemployment rate falls below the 6.5% threshold. As I have mentioned before, the Fed might want to consider nominal gross domestic product (GDP) targeting.

However, I do not expect the Fed to announce nominal GDP targeting because it would be too much of a surprise. The Fed’s dual mandate includes unemployment and inflation, which means these two indicators will remain important (perhaps this can be legally changed one day). According to the Wall Street Journal, “[Janet Yellen] and other top officials have suggested a new statement could emphasize the Fed’s interest in a broad array of indicators, rather than a single unemployment indicator”.  Although I do not know what array of indicators they will choose, I believe this is a good first step. I think it would make sense for Yellen to choose a large selection of indicators that provide a sense of financial stability. Financial stability should be an explicit factor for interest rate decisions. Regardless of what indicators Yellen mentions, I am sure she will state that interest rates will stay low for awhile.

Although the economic recovery has been disappointingly slow, the economic outlook is undeniably improving as confirmed by the February employment report. Reducing asset purchases to $55 billion per month should be a clear decision, however, adjusting forward guidance poses more issues.

[Revised] QE Tapering and its Effect on EMs: Russia’s Hands-Off Policy

As many have mentioned in their blog posts already, the Federal Reserve did not surprise anybody today by cutting back its bond-purchasing program by $10 billion, just as it said it would. Coincidentally, I had an interview with both Bank of America and Deutsche Bank today. Needless to say, that was a main topic of discussion during the interviews. Thanks to writing these blog posts each week, I was prepared.

One of the things that has been emphasized and is something I talked about a lot in the interviews is the effect QE tapering would have on emerging markets. I expected interest rates would rise after the Fed’s announcement, but due to increased investor demand the yield on 10-year U.S. Treasury bonds hit its lowest point since November (2.685%). The main reason is that investors seem to be shying away from risky investments in troubled emerging markets, in favor of less risky U.S. bonds. Even U.S. stocks took a tumble as the S&P 500 fell 0.38%.

An interesting case study for analysis of the effect of QE tapering on EM’s is Russia. Contrary to most emerging markets who are desperately trying to increase interest rates in order to stabilize their dwindling currencies, Russia isn’t even putting up a fight, letting the markets pull the ruble down without restraint.

At first glance this strategy seems unwise. As the article states, a weaker ruble means:

  1. Russian imports become more expensive, making it difficult for Russian companies to upgrade technology because equipment imports rise in price.
  2. Russian spending power abroad is slashed.
  3. Increased doubt of the ruble could significantly increase demand for foreign currencies, weakening the ruble even further and causing a surge in an already high inflation rate.

However, after closer inspection Russia’s hands-off policy has some validity.

 ‘A weaker ruble acts as a useful shock-absorber,’ said Ivan Tchakarov, economist at Citibank in Moscow, adding that letting the ruble slide gives the central bank a way to ease the impact of slowing global demand for Russia’s main commodity exports without risking higher inflation.”

Not only do Russia’s commodity exports become more attractive abroad, but also one of the main arguments against a weak ruble- high inflation- is avoided. The reason? In an already frail Russian economy, producers cannot afford to pass on the higher costs they are facing to consumers. They’d lose more revenue by increasing their prices than by absorbing the costs of a weak ruble. Although this isn’t by any means sound long-term monetary policy, I can understand why Russia is acting the way it is given its circumstances. A 6.5% inflation rate coupled with a shrinking current account surplus doesn’t give Russia much leeway to pursue quantitative easing or similar policies.