Monday, January 27, 2020

Fed Officials Weigh New Recession-Fighting Tool: Capping Treasury Yields

https://www.wsj.com/articles/fed-officials-weigh-new-recession-fighting-tool-capping-treasury-yields-11580050800



Fed Officials Weigh New Recession-Fighting Tool: Capping Treasury Yields

Yield caps would be a cousin to quantitative easing

Federal Reserve Chairman Jerome Powell on Dec. 11 discussed the last interest-rate decision. PHOTO: SARAH SILBIGER/ZUMA PRESS
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As part of their contingency planning for the next recession, Federal Reserve officials are looking at a stimulus scheme the U.S. last used during and after World War II.
From 1942 until 1951, the Fed capped yields on Treasury securities—first on short-term bills and later on longer-term bonds—to help finance war spending and the recovery.
More recently, the Bank of Japan employed something known as yield-curve control, holding rates on 10-year government bonds at zero by committing to buy those securities at whatever price is needed. Bond yields and prices move inversely.
Japan 10-year government bond interestrateSource: Tullett Prebon
%Yield cap introducedSept. 2016’202012’16-0.50-0.250.000.250.500.751.001.251.50Mar 31, 2019x-0.090%
At issue is how the central bank should manage a faltering economy when short-term interest rates are already low.
In the past three downturns, the Fed cut its benchmark rate by around 5 percentage points. The rate today is in a range between 1.5% and 1.75%, leaving less room to counteract a downturn. Central-bank officials are likely to hold this rate steady at their meeting Tuesday and Wednesday.
The Fed’s playbook for the next recession will rely heavily on two tools it deployed during and after the 2007-09 recession—bond purchases, sometimes called quantitative easing, or QE, and forward guidance about plans to hold rates at very low levels for longer than investors expect.
They are also inspecting new approaches. “The law of diminishing returns is a very powerful force in economics, and so we have to be concerned that it may also apply to quantitative easing,” said Fed Vice Chairman Richard Clarida in public comments earlier this month.
Holdings of Japanese government bonds bythe Bank of Japan, change from prior quarterSource: Bank of Japan
.trillionApril 2013, purchases beginSept. 2016, yield cap introduced2010’12’14’16’18’2005101520¥25March 2019x¥3.47 trillion
At their October meeting, officials said they thought capping yields on short-to-intermediate-term securities could be an effective way to augment their other tools.
“Short-term yield-curve control is something that is worth looking at,” said Fed Chairman Jerome Powell at a moderated discussion shortly before that meeting.
By contrast, Fed officials are unimpressed with negative rates, which have been used in Europe and Japan. They worry this policy could do more harm than good in the U.S. because of important differences in market structure.
Yield caps would be a cousin to QE. In QE, the Fed committed to purchasing fixed amounts of long-term securities. With yield caps, by contrast, the Fed would commit to purchase unlimited amounts at a particular maturity to peg rates at the target.
Treasury yieldsSources: Federal Reserve (three-month bill), NationalBureau of Economic Research (20-year bond)
%RECESSIONJuly 1947,Short-term peg endsMarch 1951,Long-term cap endsMarch 1942,Yield caps begin20-year bondThree-month bill1942’44’46’48’50’52’54’560.00.51.01.52.02.53.03.5
The goals of either approach are similar: drive down longer-term interest rates to encourage new spending and investment by households and businesses. Bond buying can also lower long-term rates by signaling the Fed’s intentions to keep rates lower for longer than markets expect.
Fed officials studied yield caps before, in 2003 and 2010, according to memos released by the central bank four years ago.
There are risks. If investors grew less willing to buy securities because they thought the Fed might abandon its peg, for example because inflation accelerated unexpectedly, then the Fed would have to increase its purchases to maintain the peg.
This happened in 1947 when the Fed raised its cap on short-term yields while maintaining one for long-term rates. Yields on long-term bonds suddenly looked less attractive to investors, who also may have doubted the credibility of that cap.

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As a result, the Fed had to purchase more bonds to defend the cap. By the end of 1948, its bondholdings rose to $11 billion from less than $1 billion, accounting for half of its portfolio.
Some officials think capping yields could deliver the same amount of stimulus while acquiring fewer securities than they did through their bond-buying programs from 2012 until 2014, when the Fed purchased more than $1.6 trillion in Treasury and mortgage securities.
“This could be pretty powerful if you could convince yourself you could manage the exit strategy and you weren’t too worried about losing control of the size of the balance sheet,” said Nathan Sheets, a former senior Fed economist who is now chief economist at investment-advisory firm PGIM Fixed Income.
The Bank of Japan, for example, has been buying 10-year government bonds since launching a QE program in 2013, but has purchased fewer bonds since mid-2016, when officials pledged to fix yields at zero.
U.S. government securities owned by theFederal ReserveSource: Federal Reserve via Johns HopkinsUniversity
.billionRECESSIONMarch 1951,Yield caps endMarch 1942,Yield caps begin1942’44’46’48’50’52’54’560510152025$30April 13, 1955x$23.64 billion
“The Bank of Japan has basically gotten it right,” said Adam Posen, president of the Peterson Institute for International Economics in Washington. The costs “are less than were first thought.”
Here’s how it might work. If the Fed cut rates to zero and concluded it was likely to hold rates at that level for at least two years, it could enhance this commitment by capping yields on every Treasury security that matures before January 2022.
“It has some appeal as a way to reinforce forward guidance. You’re going to keep rates lower for a long time, and ‘you really mean it,’ ” said William English, a former senior Fed economist who now teaches at Yale University.
To drive down longer-term yields, the Fed could pair such an approach with additional purchases of longer-dated securities with traditional QE.
Fed governor Lael Brainard made a case for these approaches in a speech last November. Targeting yields on shorter-duration securities for a fixed interval of time could ease any concerns about the exit strategy because the portfolio would be self-liquidating.
After the caps expire, “any securities that were acquired under the program would roll off organically, unwinding the policy smoothly and predictably,” said Ms. Brainard.
A tricky question could be deciding how far out on the yield curve to peg rates. Former Fed Chairman Ben Bernanke often argued that the maturity and risk-profile—not the size—of its securities holdings determined the degree to which bond purchases stimulated the economy. Under such thinking, purchasing longer-dated assets provided more stimulus.
While Japan’s program targeting longer-dated securities has worked smoothly so far, it isn’t clear how officials there will manage the end of the program.
Write to Nick Timiraos at nick.timiraos@wsj.com

Tuesday, January 21, 2020

Ray Dalio says ‘cash is trash’ and advises investors hold a global, diversified portfolio




Ray Dalio says ‘cash is trash’ and advises investors hold a global, diversified portfoliohttps://www.cnbc.com/2020/01/21/ray-dalio-at-davos-cash-is-trash-as-everybody-wants-in-on-the-2020-market.html



  • Investors shouldn’t stay on the sidelines in the 2020 market, Ray Dalio said on Tuesday, because “cash is trash.”
  • The billionaire investor thinks “there’s still a lot of money in cash,” saying that “everybody is missing out, so everybody wants to get in.”
  • Dalio doesn’t think there will be a recession this year and he said investors should look beyond the 2020 U.S. presidential election.
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Ray Dalio: ‘Cash is trash’ in the 2020 market
Ray Dalio, founder of investment firm Bridgewater Associates, said on Tuesday that he thinks investors shouldn’t miss out on the strength of the current market and they should dump cash for a diversified portfolio.
“Everybody is missing out, so everybody wants to get in,” Dalio said, speaking to CNBC’s “Squawk Box” at the World Economic Forum in Davos, Switerzland.
Dalio advised having a global and well-diversified portfolio in this market and said the thing people can’t “jump into” is cash.
“Cash is trash,” Dalio said. “Get out of cash. There’s still a lot of money in cash.”
Dalio’s firm Bridgewater manages about $160 billion. His declaration that investors should not stay on the sidelines is one he’s made before, as in 2018 he declared that those holding cash were “going to feel pretty stupid” for missing the market’s run up.
“You have to have balance ... and I think you have to have certain amount of gold in your portfolio,” Dalio said, reiterating his call last year that gold will be a top investment in the years to come.
While he endorsed buying a bit of gold, he warned against more speculative investments like bitcoin.
“There’s two purposes of money, a medium of exchange and a store hold of wealth, and bitcoin is not effective in either of those cases now,” Dalio said.

Dalio’s warning for the next five years

Dalio doesn’t think there will be an economic downturn this year and he said investors should look beyond the 2020 U.S. presidential election.
“If you get a downturn – and there’s a good probability in the next [presidential] term you’ll get a downturn – and you don’t have effective monetary policy and you have people at each others throats, I’m worried about that,” Dalio said.
“I would say there’s a 20% chance every year [of a downturn],” Dalio added.
He believes the Federal Reserve is now in a position where it can longer stimulate the U.S. economy like has in the past, notably by lowering interest rates.
“You used to push a button and it would go up,” Dalio said.
But if U.S. interest rates continue to fall, and U.S. federal politics remain highly divisive, Dalio worries that the economy won’t be able to bounce back like it has in the past.
“We’re going to have larger deficits which we’re going to print money for,” Dalio said. “At a point in the future, we still are going to think about what’s a storeholder of wealth. Because when you get negative yielding bonds or something, we are approaching a limit that will be a paradigm shift.”

Friday, January 3, 2020

‘Gut Feelings’ Are Driving the Markets Valuations are high, but investors are still willing to hold, because of a visceral emotion driven by President Trump.


https://www.nytimes.com/2020/01/02/business/gut-feelings-are-driving-the-markets.html



Gut Feelings’ Are Driving the Markets

Valuations are high, but investors are still willing to hold, because of a visceral emotion driven by President Trump.
redit...Mark Pernice
The United States stock market is trading at a very high level today. The data show where the market stands, but don’t tell us how it got there. For an explanation of that, we need to take into account a factor that sound very unscientific: “animal spirits,” sometimes called “gut feelings.”
First, let’s look at some of the numbers. More than 30 years ago, the economist John Campbell and I developed what we have called the Cyclically Adjusted Price Earnings (C.A.P.E.) ratio, a measure that enables the comparison of stock market valuations from different eras by averaging the earnings over ten years, thus reducing some of the short-term fluctuations of each market cycle. C.A.P.E. reached 33 in January 2018 and is almost as high now, at 31. That number might seem meaningless in itself, but it is significant when you consider that it has been as high or higher on only two occasions: 1929, just before the 85 percent stock market crash ending in 1932, and in 1999, just before the 50 percent drop at the beginning of the new millennium.
People will point this year to low interest rates to justify the high C.A.P.E. ratio. But interest rate levels historically have not correlated well at all with the C.A.P.E. For example, low long-term rates did not explain the high C.A.P.E. ratios in 1929 and 1999, nor did rising long-term interest rates explain subsequent market crashes.
That brings us to another factor, which John Maynard Keynes called “animal spirits.” It is a sense of optimism and ready energy to be entrepreneurial and take risks, and it has been adjudged to contribute to high stock market levels. Animal spirits are not adequately measured by business consumer confidence indexes, because the surveyors do not probe for such deep feelings.
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High animal spirits in the stock market are often associated with the disparagement of traditional authority and expert opinion. This popular narrative often advocates relying on your “gut feelings” to try what experts say is doomed to failure.
President Trump uses this kind of language. Recently, for example, he said “I have a gut, and my gut tells me more sometimes than anybody else’s brain can ever tell me.”
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Make America Great Again (MAGA), Mr. Trump’s election slogan, remains on his supporters’ lips. The question for the market outlook hinges partly on how the Trump narrative — the notion that he and his followers are on the road to a triumphant future — will evolve.
Belief in the MAGA narrative would probably encourage people to buy into the stock market, even at elevated levels, thinking it will go up. It is more complicated to anticipate the actions of those who do not believe in Mr. Trump’s supposedly intelligent gut.
While skeptical themselves, they may well believe that enough other people believe, so the markets will thrive, at least in the short term. Investing for the short term — “speculating” is another word for this — tends to be influenced by thoughts that investors have about the thoughts of other investors.
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Continue reading the main storyThe rise of an explicit belief in irrationality like this one is troubling on many levels. An essential element of a modern democracy is the wide dispersal of knowledge among a multitudes of experts. But there is reason to think that respect for science has been diminishing over the past decades. References to the “scientific method” peaked in news and newspapers in the 1940s, and are lower today. Instead, we have the phrases “gut feeling,” “visceral feeling,” and “trust your gut,” which are proliferating. None of these phrases had any currency before 1960, and they have been rising, going viral ever since.
This “gut feeling” narrative is not conterminous with the current bull market in its entirety, but seems to be an important factor permitting the United States economy and markets to move ahead amid widely reported fears of a coming global recession.
Long before the Trump presidency we saw milestones in public awareness of thinking that comes “from the gut.” For example, there is the 2001 best seller by Jack Welch, “Jack: Straight From the Gut,” (written with John A. Byrne) about his successes as chief executive of General Electric from 1981 to 2001. Mr. Welch described his management style as intuitive, and not relying on experts, whose analyses he viewed as often phony. Mr. Welch says, for example: “I crossed out the payback analysis on his last chart. I drew an “X” over the transparency and scrawled the word Infinite to make the point that the returns on our investment would last forever. I meant it.” Whether Mr. Welch’s supposed genius has been called into question by the sharp drop in share value of G.E. after he left the company is a matter of debate.
The 1997 book “Rich Dad Poor Dad, written by Robert Kiyosaki, with Sharon Lechter, described two fathers (one his own, the other a friend’s). The book’s publisher, Plata Publishing, reported that the book sold nearly 40 million copies as of 2017. His own, poor dad had college degrees, deferred to authority and told his son that many things were impossible. The uneducated but rich dad told him he should think about how he can make his dreams a reality. Donald Trump comes across to many many people rather like the rich dad. (Kiyosaki and Trump have co-authored two books, in 2006 and 2011.)
Then there is the 2011 book “Steve Jobs,” by Walter Isaacson, which described the co-founder of Apple this way: “Jobs was more intuitive and romantic and had a greater instinct for making technology usable, design delightful, and interfaces friendly.”
We are being saturated with these kinds of narratives today: describing inspired young people, some of whom drop out of college, who surpass overly polite conformists pursuing dull, bureaucratic work lives. For people who buy into this dream, one simple step is to avoid the mistake of missing out, by acting like a rich person and buying stocks.
This is obviously not an explanation for the level of the entire market, but it is surely part of it.
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We have a stock market today that is less sensible and orderly than usual, because of the disconnect between dreams and expertise.
Robert J. Shiller is Sterling Professor of Economics at Yale. He is also a consultant to Barclays Bank on C.A.P.E. related indexes.

Thursday, September 19, 2019

Economy faces risks, not recession: Bernanke


https://www.reuters.com/article/us-usa-bernanke/economy-faces-risks-not-recession-bernanke-idUSWBT00789120071108




WASHINGTON (Reuters) - Federal Reserve Chairman Ben Bernanke told lawmakers on Thursday the U.S. economy did not appear headed for recession, but warned growth could prove weaker than expected and inflation higher.