33: How Monetary Policy is Now Being Outsourced (Sort Of)

It's Thursday, April fourteen. I'm Daniel Moss, Executive editor for Global Economics at Bloomberg News. My co hosts Archieto and Tory still will are out this week, so it's just me. We Most of us familiar with the concept of outsourcing, the idea that companies and governments find it cheaper or more efficient to have outside groups hand all things like customers support, legal services, programming, bill collection, data entry, and so on. And yes, sometimes this takes place overseas a

common example of the ubiquitous call centers. Whatever you want to check your bank, balanced, book a hotel, or inquire about something on your cell phone bill. But outsourcing monetary policy that seems to take it to a whole other level. Get in a way, that's what the Federal Reserve has done. Chair Janet Yellen effectively said as much last week when she told an audience in New York that the FED dialed back its projections for how many times it will

increase interest rates in response to investors dialing back. First, our colleague Rich Miller listened to her speech, picked up on the theme, and wrote about it for Bloomberg News. Rich has been following the US economy and the FED for more than three decades. He joins us from Washington, Rich, great to have you. Thanks for having me, Dan. Well, the textbooks tell us that markets are, in theory supposed to respond to what you make is saying. Do this

seems like the world has been turned upside down. What's going on? Well, first of all, I just want to say, of course, Janet Yellen didn't say in her speech that the Fed is outsourcing monetary policy, and Feed officials would undoubtedly object to that. But but what she laid out in the speech, sure as heck, sounded like that. What happened was the markets got a little bit scared about global growth in China, so they adjusted down the amount

of interest rate increases they expected from the Fed. In response, long term interest rates went down. Those long term interest rates lower long term interest rates provided the economy with some stimulus and helped keep the economy on track in the face of this jitters about global growth. So Janet Yellen said, this is great. This is like an automatic stabilizer.

I mean, it's sort of sort of like an ideal marriage where your partner sort of knows you so well that you don't even have to ask for the present for your birthday. She or he gets it before you even ask. Well, we know the FED keeps a close eye on markets. They said that that's no secret. But this does seem to elevate it to a new level. Yes, yes it does. I think there was a little bit

of an ulterior motive here. The FED has gotten slammed on Capitol Hill by a Republican law may because and by some Republican leaning leaning economists for following a policy that's too discretionary two seat of the pants, and these people, these lawmakers claim that investors don't understand what the Fed's gonna do and that hurts the economy. Yelling was basically said, was trying to say yes, the markets do understand what we're gonna do, and in fact they had just before

we adjust. So I think there was a little bit of a political backstory here that's going on the way she described the relationship between the two of them. What are the risks of this approach? Uh, Well, the risk are uh what mis misunderstandings and upsets like in a marriage, right, we're you know, hearken back to what was at the middle of two thousand and fourteen. Investors work evinced that the FED was going to have what was called quantitative

easing forever. It was going to keep on buying bonds in the market and keep on supporting the economy. Then Chairman Ben Bernanky said, well, maybe we're gonna end it, maybe we're gonna taper it, and then the markets through a hissy fit. They had a tantrum, Right, So that's that's the risks that there's misunderstandings that could then lead to blow ups later that could hurt the economy. It really makes me wonder again to use the marriage analogy,

who's in charge here? Who right right now? Yeah? Well, I guess in some marriages, uh, someone is clearly in charge and and someone isn't. But I think in most it's kind of a constant, kind of at least in mind, constant kind of jockeying back and forth, trying hopefully to get to a common goal, which in this case is you know, a well functioning economy. I mean, one of

the problems is is that the goals don't always fully align. Usually, you know, investors want are well functioning, growing economy, but sometimes they were more interested in, you know, the fact that their investments are doing well a bad But I think it's never clear. I think there's a constant learning process back and forth between the markets and the economy, just like in a marriage. Just to use another analogy, isn't this a little bit like giving a drug addict

more heroin? I mean, if you empower the markets to that extent and publicly say you did it after markets did it, doesn't this just risk emboldening investors and they're going to want more and more and more and more and more, and the FED finds itself trapped. I think there is a risk for that, and then eventually the FED will have to disappoint the markets, and then you get this kind of upset like we had with the

taper tantrum. So I think there is a definite risk, and I guess it's up to the FED to try to communicate clearly with the markets what when it thinks they're they're going too far. It also, I mean, we've gotten used to seeing the markets want more and more stimulus. But it is kind of interesting when you think about the initial years after the Great Recession. If you look at the markets back then, they were always expecting the FED to raise interest rates like a year out, but

the FED didn't have any intention to do that. So the FED eventually had to go out and explicitly say, look, we aren't going to raise interest rates until like the middle of two thousand fifteen. Don't worry boys and girls. So you know, there is risks, but that's just the way things work. And what is the risk that Fed

officials misread the message that markets are conveying. I mean, I think it's great obviously, Um I guess, I guess trying to stick with this marriage analogy, you know, one of the partners is kind of someone who's whose moods flips from elation to dejection, and that's the markets right as as it flips. As investors flipped from greed to fear. Then you have the other partner who's maybe stolid and looks at models and rarely changes his or her mind.

And sometimes the one who's, you know, saying you know the end is near is right. Oftentimes the one who's saying the end is in he is not right. But sometimes the one who says don't worry, be happy or

don't worry things are copasetic is wrong. So you know why they have, you know, a huge they fed have a huge bunch of people in New York sort of in constant contact with the markets, trying to figure out what the message of the markets are trying then to say, well, do we agree with what the markets are worried about or what the markets think of doing, or do we not? Well, I hope this marriage doesn't end in an expensive custody trial. Definitely, Definitely,

it's been great to have your perspective. Keep up the good work. Thanks, thanks, thanks a lot for inviting me. Enjoyed it, and now a would from our sponsor. This episode of Bloomberg Benchmark is sponsored by HSBC, with over eight thousand global relationship managers on the ground in over

sixty countries. HSBC makes your global ambition their local business HSBC. Well, the issues that Rich outlined touch on things you know, we wrestle with daily here at Bloomberg News and helping us flesh it out and maybe even have it out. Two of my colleagues, Bob Burgess and Madeline Limp. Bob is executive editor for Markets and Madeline is executive editor for Bloomberg First World, tell us a little bit about

what that actually is. Hi, Dan, thank you for the introduction, and Bloomberg First Wood is a very short bullet point service about markets, issues and news that's of interest to markets in a very quick and condensed form. Well, Bob, you've got to feel vindicated by this Markets of one, right. I'll never be able to mix it up with you in quite the same way in our morning and afternoon news meetings. Rich. I think I brought up some very interesting topics. But the one thing Rich didn't talk about

was markets are always forward looking. Okay, markets are not necessarily reactive to central banks, but they're more pricing in what is going to happen in the future. We're it's going to be the cost of money six months out, a year out, and so what we've seen over the past three years is that the markets have been continually more right on the outlook for for the economy and um the market has generally been more pessimistic on the

pace of growth, the FED has been more optimistic. And what we've seen over the past twelve to eighteen months, maybe even two years, is that the Fed's outlook in the economy has continually come down to the markets view of the economy. And yet markets will move in response to specific central bank events on any given day, often the way they should. You're drawing a distinction between the

longer term and the short term. Markets will always have immediate reaction to whoever central bank does on a certain day, but the markets are going to be pricing in what is going to be, what they think is going to be, or what the market things is going to be happening four months out to a year out. And one of the big debates that's going on in markets these days, and you and I and Madeline have have talked a lot about this is just how effective is central bank

you know, policy these days? As you and I have debated in Madeline has Uh, We've all talked about a lot in recent weeks is is sort of the effectiveness of of global central banks and policies. We talked a lot about the diminishing returns as central banks are getting

from uh, this era of lower no interest rates. Uh. Kid Jokes, who's the chief market strategist at Society Generally, actually had a very good no doubt talking about how after the trillions of dollars of money that has been pumped into the global economy by central banks, here we are in two thousand sixteen, able two thousand sixteen, and all we're seeing is very low growth. This is your

impotent point exactly. We're going to get to that in just a second, because I've got something for you all that. But Madeline, and your experience other markets always right, and how do you determine what they're actually saying? You can see what a phenomenal logical market level is, but how do you know that the interpretation is right? Well? I think it all depends on your perspective, right, And always

remember my short position is your long position. If you believe something is going up, you've got to sell it to somebody. So it's it's a given take situation. But I do think that more broadly in a market based capitalist system, as we have for aessential bank, not to pay attention to the markets and what the markets are saying. These are ultimately smart people who are doing their analysis and putting their money on the line, or their investors

money on the line. That you can't really ignore that. And I would sort of warn that you know, where not talking about the stock market here and it's various ups and downs. Nor are we talking about the FX

markets another completely different story. We are talking about the bond market here, which can be volatile admittedly, but if you look at the ten year yield since December, it has been more or less on a downtrend and two percent is the level that is really hard for the ten ure yield to get above in the US, and I think that tells you something about what investors feel

is the outlook for growth. But for both of you in your jobs, one of the things I find frustrating is how do you cut through the noise and find out what actually is the central point? Because it does feel like one day market participants are saying that there needs to do this and they're hopeless at that. Then the next day they're saying precisely the opposite how do you sort out, to quote Nate Silver, the signal from

the noise. As Medal has said, there's always going to be a buyer and a seller, and you're always going to have the ups and downs of the markets. But what we need to do every day is is take a step back, take a look at the big picture and try to get a sense of what does the bigger picture or message that the markets are are are sending. And I think that in these days it's clear that the markets are signaling that the outlook for the global economy is is pretty anemic. I mean, as Madeline said,

he's talking about the tenure yield. Globally, bon yields on average are down one to one point three percent, a record low. Does anemic often get conflated, mistakenly with disastrous If we go back to January, in the first half of February, the narrative coming not just from the markets, but from some family serious economists as well, you could be forgiven for thinking the apocalypse was with us, and

now here we are. The macro economic data hasn't changed dramatically, certainly within the US, China hasn't fallen apart, and the Eurozone is like, you know, hanging in there. Well, what I would say is you're right. I mean, at the beginning of the year, there was a number of different events that happened that caused a lot of terminal markets. You had China weakening its its currency, raising concerns about

a currency war. Oil and commodities continued to collapse um raising concern about deflation, global recession, defaults by energy companies that have raised a hundreds of billions of dollars in recent years. You had all these events coming together at the same time. You had the Bank of Japan going into negative interest rates and the European Central Bank going further into a negative interest rates, and the message that was sending the markets was the central banks are not

the answer. After all these years and all of they've done, they still can't fix the global economy. Now we're in impotence territory for one of a better time. Right. But you know, so I think that you know, taking a look at all that the first couple of months of the year, it was very turbulent markets and markets were, um, we're reacting to that. They weren't just reacting to to what central banks were doing. March was a tremendous comeback.

I think in the SMP we were down ten percent through mid February and then the SMP five recouped all that through the end of March. It was the biggest turnaround in history for the markets. So that makes me wonder who was right in January February or were they both right? They were both right. The markets are not signaling now that it's all clear, while back in February

and January. In February, there's a lot of concern about as I said, deflation, global recession that's come out of the market, but the market is not signaling that it's all clear, right. And I would just add to that with Bob says, is that you have to just be mindful of when when you talk about the market, what

your how you look at things. I really do think the perspective rely matters if you take what the market is pricing in now for it, like Bob says, in the next years ahead, you know, rather than looking at the noise, you have to kind of look at the

long term and then sort of from there. And it wouldn't be tenable to have the market pricing in you know, very low likelihood of maybe even two rate tags this year and the Fed still maintaining no, we're going to raise rates for You can't have that dicotomy go on for too long. At some point, something has to converge.

And I think for the FED to look at the model, and you know, the FED looks at it's economic models, the market looks at their economic models, and I think taking it together, it's just using all the data that you can to formulate the best policy that you can come up with. I think right or wrong is a hard question to answer, because ultimately, if the policy is set right, then yes, you should see growth pick up. Right come the middle of the year, the picture looks different.

You're trying to create the conditions now that foster growth in the future, and I think that's a really hard balance to achieve and we shouldn't be trying to parse too much out of the day to day moves, and I would really warn against looking too close listens at that point. But but the other thing, you know is I think what happened at the beginning of the year is people were setting up for the FED. You know,

the FED was tightening policy. They started in December, and people were trying to set up for that, and there was a lot of volatility around and I think that added to the whole concern of what was going on, and some big names thought that they would have to revert to queue and that they would take interest rates off the table together. Now they've scaled back their projections, as Rich was just saying, but they haven't taken them off the table, and they certainly haven't eased Let's get

back to the eye word body. I can buy the argument that the central bank efforts now suffering diminishing returns, but there still is a return there. Are you sure it's impotence. I think it depends on how you look at it from the market perspective. If you're looking about at strictly what central banks are doing to asset prices, it's probably not evident because there's still the e c B, the b o J, they're still buying bonds, um and

other financial assets. The federals are even though it's not creating money to buy bonds, it's reinvesting the proceeds from maturing bonds into new security, so that money is is cycling back in. That's actually that's supporting the bond market.

There's no question about it. But when people start talking about whether the central banks and the Fed are are impotent or not, they are talking really about the transition mechanism in the sense that is the wealth in the financial markets that the central banks have created, is that leaking into or helping the real economy, And in a lot of ways they're saying that it's not helping the

real economy. Take a look at them the the Atlanta Fed in its estimates of GDP for the first quarter, I think it's down to below one percent now the beginning of the year was supposed to be something between two and a half to three so that I think when the markets see that, sees that it tells them something. To be fair to the Atlanta Fair, that is a tracking estimate which does change week by week depending on

incoming data. And I just wanted to say that, well, that is the crux of what the ECB is doing to get away from the vetch just a little bit. They're buying program of corporate bonds. What will really matter is whether that trickles truth too small and medium sized companies, and as we know in Europe, those are much less dependent on the markets and do a lot more through

bank financings. Are any of the market participants that your teams are talking to saying that the initial stimulus, and by initial I mean say from late two thousand and seven through two for arguments, say, are they saying those were ineffective in staving off depression? There's no question about it. But but that was two thousand, two thousand ten, two thousand seven, two thousand and ten. We're now in two thousand sixteen. It doesn't seem to be working as effectively

as it did then. So that's an argument for diminishing returns. It is, but remember when when the FED begins to stop reinvestment, that's going to be another big adjustment, particularly for one market that never gets much mentioned, which is the mortgage backed securities market. That is going to be something to watch. Well, Madeline, you're responsible for first word. That means for the last word. I do have to come back to Bob by all means well he said

it as metal as said earlier. I mean, if you're trying to answer the questions about whether markets are right or wrong, there is no answer to that. The markets are going to is going to vacillate from day to day on the incoming data. But if you take a step back, take a look at the markets as a whole, the message that they're signaling is that central banks can't do it alone. And meanwhile, every Fed official says, hey, but the April meeting is still alive. Meeting or Bob

and Madeline, thanks for joy and us. We're going to definitely have you back, and thank you to all of you for listening to Bloomberg Benchmark. We will be back next week. Until then, you can find us on the Bloomberg terminal and Bloomberg dot com, as well as iTunes, pocket Cast, Stitcher and a few others. And while you're there, take a minute to rate and review the show so more listeners can find us and do let us know

what you thought of this show. You can talk to and follow us on Twitter at at Daniel Moss, d C at Tory Steelwell, and at Aco seven. This episode of Bloomberg Benchmark was sponsored by HSBC. With HSBC, you have up to the minute visibility and control of your global cash positions so your business can move at the speed of opportunity. HSBC