Is it time for the Federal Reserve to pursue a single mandate?

12 USC 221 of the Federal Reserve Act provides four main purposes for the Act:

  • To establish Federal reserve banks;
  • To furnish an elastic currency;
  • To afford the means for rediscounting commercial paper; and
  • To establish a more effective supervision of banking in the United States.

The legislation provides statutory support for the Federal Reserve System’s objective of regulating the United States’ money supply.  Specifically, under 12 USC 225a, the Federal Reserve System’s monetary policy objective is to:

“[M]aintain long run growth of monetary and credit aggregates, commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”

Among the tools the Federal Reserve System uses to achieve its monetary policy goals are the usual suspects: open market operations; the discount window and discount rate; reserve requirements; and interest on reserve balances.

Over the next several days I will be addressing the monetary policy and legal questions, “What factors does maximum employment address?” and “What factors do stable prices address?”

The media when reporting on maximum employment often references the unemployment rate for labor, while referencing the consumer price index when addressing the achievement of stable prices.  My issue is, why is labor the be all and end all of the full employment issue?

If the Federal Reserve’s goal is to maintain long run growth of money and credit that is commensurate with the economy’s long run potential to increase production, shouldn’t the Federal Reserve System consider or assess the full employment of America’s productive capacity beyond labor? 

The media gives productive capacity a secondary thought and its lack of emphasis on productive capacity does not, in my opinion, keep the trading and merchant community fully informed on how well the economy is actually doing.

I would make the same argument for prices as well.  The Federal Reserve System’s narrative is that too much inflation is bad and it has to be contained.  But is that narrative truly in line with the expectations behind wealth accumulation?  Is it line with creating in consumers a necessary illusion of wealth that results from inflated home prices? 

Growth in asset values gives the average American the impression that her wealth is increasing.  She wants to use her house as an automatic teller machine but can’t do that if rising interest rates slow down demand for her house resulting in a decrease in her value.  Is monetary policy helping her achieve that balance?

It is clearer at this point to see a more direct connection between the Federal Reserve System’s influence on the interbank market for excess reserves and interest rates versus pursuing a four percent unemployment rate (historical full labor employment) via its monetary tools.  For that reason, should not the Federal Reserve focus solely on interest rates?

Could a single mandate may be better for traders who need as clear an assessment of the markets as possible?  Maybe. Maybe not. Let’s explore.

Alton Drew

18 May 2022

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Joe Biden and the Federal Reserve: The competing inflation fighting narratives …

John Williams, president of the Federal Reserve Bank of New York, today remarked on the state of inflation in the United States and the Board of Governors of the Federal Reserve System’s (“Board” or “Federal Reserve”) efforts to address rising prices throughout American markets for food, energy, other goods and services. 

Mr Williams reminded listeners of the Board’s dual mandate of maintaining stable prices and attaining maximum employment and reiterated that the Board has the monetary tools to address inflation stemming from congestion in the supply chain, China’s recent attempts to combat the surge in new Covid cases, Russia’s invasion of its Eastern European neighbor, Ukraine.

With demand exceeding supply and a tightening labor market, Mr Williams expects monetary actions to cool the demand side of the equation.  The Board has already embarked on cooling down the demand side, first by announcing during its last Federal Open Market Committee meeting (a committee that Mr Williams is a member of) an interbank overnight lending rate range of .75% to 1.00%. 

In order to influence its member banks to borrow excess reserves from each other within this range, the Board will begin unwinding its holdings of US Treasury notes and agency-backed securities on 1 June.  In theory, as more securities hit the market for sale, the price of these securities fall while the interest rates paid on these securities increase.  As interest rates increase, the Board believes the increase will be accompanied by a slow-down in lending by commercial banks and borrowing by businesses and consumers which is expected to result in a less heated economy. 

But as the campaign season heats up in the United States, how well will the Biden-Harris administration manage the political economy during a downturn?  Today, Mr Biden, in remarks addressing inflation, spun a narrative that inflation is the result of Vladimir Putin’s antics in Ukraine and by a federal budget deficit caused by wealthy individual and large corporations’ unwillingness to pay their fair share of taxes. 

Admitting that monetary policy is the purview of the Board of Governors, Mr Biden offered up a fiscal solution contained in his Build Back Better agenda.  Components of the Build Back Better agenda offered in his remarks included investment in renewable energy infrastructure; passing clean energy and electric vehicle tax credits; promulgating fuel regulations that would increase miles per gallon for fossil fuel vehicles; and releasing one million barrels a day from America’s strategic petroleum reserves.

Throughout Mr Biden’s speech, Vladimir Putin’s name was cited repeatedly giving me the impression that remarks were intended to drum up electorate support for continued U.S. and NATO involvement in the Ukraine-Russia conflict versus resolving the inflation issue.  I also get the sense that by early summer, Mr Biden will tie Mr Putin to former president Donald Trump, thereby turning the inflation messaging into a strategic communication that garners more electoral support for the Democratic Party.

As an economic narrative, Mr Biden’s fiscal and legislative policy will depend on a defacto gridlocked Congress.  By keeping attention on Mr Putin and to a lesser extent Mr Trump, Mr Biden hopes Americans do not notice his inability to manage the political economy out of an inflationary mess.

All ears should stay open to what the Federal Reserve says and eyes open to what the consumer does.  While the Board lost credibility by continually repeating that inflation was transitory, it is in a position to take faster and more measurable action via monetary policy as opposed to Mr Biden’s fiscal and legislative agenda.

Alton Drew

10 May 2022

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Federal Reserve News Scan: Federal Reserve today releases data on commercial paper, foreign exchange, and interest rates

Board of Governors

At 1:00pm today, the Board of Governors of the Federal Reserve (the Board) releases data on commercial paper.  At 4:15pm, the Board releases data on foreign exchange rates and interest rates.

Commercial paper refers to short term, unsecured debt typically maturing between one days to 90 days.  It is often issued at a discount, without paying coupons, and matures at face value. See current rates on commercial paper here.

Selected interest rate data includes data on the effective federal funds rate, commercial paper, bank prime loan, discount window primary credit, and U.S. government securities.  See current rates here.

Interbank Market News Scan: PBOC announces loan prime rate …

Central Bank of the People’s Republic of China

Under the authorization of the People’s Bank of China (PBC), the National Interbank Funding Center (NIFC) announced the Loan Prime Rate (LPR) on February 21, 2022 as follows: the one-year LPR is 3.7% and the above-five-year LPR is 4.6%. The rates are effective until the next release. See article here. Source: The People’s Bank of China.

In order to keep the liquidity of the banking system adequate at a reasonable level, the People’s Bank of China conducted reverse repo operations in the amount of RMB10 billion through interest rate bidding on February 21, 2022. The reverse repo operations have a maturity of seven days at 2.10%. See article here. Source: The People’s Bank of China.

The following are the central parity rates of the Chinese currency renminbi, or the yuan, against 24 major currencies announced on Monday by the China Foreign Exchange Trade System. See article here. Source: China.org.cn

Monetary Authority of Singapore

The Monetary Authority of Singapore (MAS) announced (last Friday) that it will further extend the MAS SGD Facility for ESG Loans [1]  (the Facility). This extension will complement the six-month extension of Enterprise Singapore’s (ESG) Temporary Bridging Loan Programme  [2]  (TBLP) from 1 April 2022 to 30 September 2022. 

2   The Facility will continue to provide Singapore Dollar (SGD) funding to eligible financial institutions [3] (EFIs) for a two year tenor. A revised interest rate of 0.5% per annum [4] will apply for funding provided from the May 2022 application window onwards, to better reflect interest rates in Singapore, which have risen alongside the economic recovery. 

3   Since its introduction in April 2020, the Facility has disbursed a total of S$14.2 billion to EFIs in support of their lending to companies under the ESG Loan Schemes. Collectively, the Government’s risk sharing through the ESG Loan Schemes and MAS’ lower-cost funding through the Facility will continue to keep borrowing costs low for local enterprises to support their cashflow needs.

  1. [1] The Facility was established on 20 April 2020. The Facility was extended twice on 12 October 2020 and 5 July 2021, to complement ESG’s two extensions of the TBLP, the latest of which was from 1 October 2021 to 31 March 2022.
  1. [2] The TBLP was introduced in March 2020 for a year to help companies access working capital for their business needs during the COVID-19 crisis. The TBLP was extended twice on 12 October 2020 , and 5 July 2021 , the latest of which was from 1 October 2021 to 31 March 2022. On 18 February 2022, ESG has announced a further extension to 30 September 2022.
  1. [3] Banks and finance companies participating in the ESG Loan Schemes, which refer to the TBLP and the Enterprise Financing Scheme – SME Working Capital Loan, are eligible to tap on the Facility.
  1. [4] Since April 2020, the interest rate was 0.1% per annum for a two-year tenor to EFIs. Funding provided to EFIs in the February, March and April 2022 application windows will continue to be at the interest rate of 0.1% per annum for a two-year tenor.

Source: Monetary Authority of Singapore

Part of reading the United States’ currency value is reading the underlying shift in its cultural values.

Commentary

The United States is at a crossroads in terms of its culture. A corporate democracy such as this one sees elected officials willing to deficit spend on programs designed to buy votes from an electorate increasingly under stress due to the uncertainty of an economy that may not be able to provide for their wants and needs. According to the Congressional Budget Office (CBO), America’s fiscal year 2021 budget deficit is approximately $3.003 trillion. While estimated revenues totaled $3.842 trillion, FY2021 outlays were estimated at $6.845 trillion. Fiscal year 2020 saw estimated revenues at $3.420 trillion with outlays estimated at $6.552 trillion. The FY2020 deficit was higher than FY2021, coming in at $3.142 trillion.

I would expect the Administration to argue that the last two years saw the federal government increasing its outlays to combat the Covid-19 pandemic, but if we go back 40 years, we find not only expected increases in outlays and revenues, but increases in outlays far outstrip increases in revenues. For example, FY1982 outlays were $.746 trillion compared to FY2021 outlays of $6.845 trillion, amounting to a 818% increase over the 40 year period. The increase in revenues over the same period amounted to 522%, where FY1982 revenues totaled $.618 trillion and FY2021 revenues came in at $3.842 trillion.

In addition, mandatory spending, which is dictated by past law that sets out mandatory requirements for spending on items such as social security, Medicare, and income security programs, increased 1,211% between FY1982 and FY2021. Meanwhile, discretionary spending, where a program is approved during the congressional appropriations process, saw a 407% increase in outlays between FY1982 and FY2021. The programs funded during this process include national defense, transportation, education, and housing.

Democracy is expensive. As politicians carve out “alphabet fiefdoms” ie, BLM, LGBQT+, Latinx, DEI (diversity, equity, inclusion programs) etc., the promises made convert into programs that have to be paid for. Low interest rates over the last decade and a half have accompanied the expansion in spending. Cheap money leads to more spending. For example, according to data from the Federal Reserve, the current prime lending rate is approximately 3.25%. This represents a 70.4% decline in the prime rate since 8 August 1983.

In addition, the rates on Treasury debt issued to fund government programs have been falling steadily since January 2000. According to data from the US Treasury, interest rates reflecting long term composite debt in excess of ten years has fallen from 6.87% in January 2000 to 1.89% in December 2021.

Democracy is expensive, but the current low interest rate environment gives American politicians the impression that democracy is affordable. With every new demand from small but vocal factions along the political spectrum, the wider the interest-rate driven deficit.

I have started to liken a currency to a coupon you get from a fast food restaurant. No matter how deep the discount, the crappier the food, the less valuable the coupon. The US Treasury-Federal Reserve Fast Food Corporation is no different. The current rate of inflation (6.8%) that destroys its spending value compounds the damage from lower rates of return and from increased government spending designed to buy votes while providing little other value to the currency holder.

Alton Drew

9.01.2022

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Disclaimer: The above is provided for informational purposes and should not be construed as financial or legal advice or as creating an agreement to provide financial or legal advice.

Interbank Market News Scan: Bank of England to announce interest rate targets today

Interbank, central bank, Bank of England. At 12 pm GMT (8:00 am EST), the Bank of England (BOE) releases its monetary policy report today including its target interest rates.  The current bank rate is set at 0.1%.  The bank rate determines the interest rates the BOE pays to commercial banks which in turn impacts rates paid by commercial bank borrowing customers.  This rate is important to traders because it provides valuable information that can be used to determine changes in inflation and yields on government bonds which in turn provides the trader with insights as to where foreign exchange rates will move.  

The BOE’s current inflation target is 2.0%, but actual inflation is running at 3.1%.  Since November 2009, the BOE has purchased £895 million in corporate and government bonds as part of its quantitative easing program.  QE is intended to help lower interest rates and stimulate growth in the British economy.

Traders should contact their brokers for more information on how BOE’s interest rates decision may move foreign exchange rates.

Interbank, central bank, Federal Reserve.  Yesterday, the Board of Governors of the Federal Reserve System announced that its federal fund and discount window rate target would remain between 0-.25%. In addition, the Federal Reserve will begin to reduce later this month its monthly purchases of US Treasury bonds and agency mortgage-backed securities.  It will reduce its monthly purchase of US Treasurys from $80 billion to $70 billion.  It will reduce its monthly agency mortgage-backed securities from $40 billion to $35 billion.

The Federal Reserve asset purchases were designed primarily to keep interest rates and stimulate the economy during the COVID pandemic.  As more Americans are vaccinated and the negative impact of the supply chain congestion wanes, the Federal Reserve is seeing more reasons to trim its asset purchases.

The Federal Reserve has made it clear that the decision to taper asset purchases and the decision to raise the federal funds rate are separate issues.  If, however, the taper policy was implemented to stimulate the economy by keeping interest rates low, traders should expect upward movement in interest rates as a result.  Increased interest rates may have an impact on the direction of foreign exchange rates regardless of a Federal Reserve decision to increase the fed funds rate.

Traders should contact their brokers for more information on how the Federal Reserve’s fed funds rate and tapering decisions may move foreign exchange rates.

Alton Drew

4.11.2021

Disclaimer: The above is provided for informational purposes and should not be construed as financial or legal advice or as creating an agreement to provide financial or legal advice.

An importer wants to short the dollar …

Tywin Lannister decides to invest in the import/export business.  He wants to import certain goods from the United Kingdom and resell them in the United States.  He estimates that he will need 7.5 million British pounds (GBP) to purchase, package, process, and deliver his British goods to the U.S. 

At an exchange rate of $1.3740 per British pound, he estimates borrowing $10.305 million from his US bank.  The borrowed amount also includes his estimated profit.

To sweeten the deal with the prime brokerage division of his bank, he offers up $1.05 million dollars in cash and securities as collateral.

Lannister’s business venture so far in Great Britain is a success.  His take comes in (for the purpose of this discussion) at the estimated 7.5 million GBP which also includes his profit.  He would not mind expanding his profit so he hopes that the dollar weakens or depreciates. Fortunately for Lannister the dollar price of a pound has increased to $1.5801.  After converting his pounds to dollars, he realizes $11.85 million, and after repaying his loan, he takes home approximately $1.54 million in profit from his venture.

Lannister likely benefited from a number of market forces.  For example, incomes in the US may have been increasing faster than those in the UK thus increasing demand for the UK’s exports and currency.  The UK’s currency appreciates versus the US.

Prices in the US may have been rising rapidly when compared to prices in the UK. The resulting demand for lower priced UK products would have resulted in an appreciation of the UK’s products and currency.

In addition, interest rates in the UK may have risen higher than in the US, incentivizing the movement of money from the US to the UK resulting in an appreciated UK currency.

A trader’s sound monetary policy strategy will emphasize interest rate moves, but will not discount to zero the other market forces that impact currency values.  Lannister no doubt kept his eyes on all the factors, but given that a central bank is the “farmer” of its nation’s respective currency, Lannister, and any other importer, will pay close attention to the interest rate actions (monetary policy) of its central bank.

Alton Drew 23 September 2021

Interbank Market News Scan: Reserve Bank of Australia expects upward path on interest rates …

9 August 2021, 9:25 pm EST

AUD/USD

No reports today hinting at any changes in the Reserve Bank of Australia’s decision to reduce weekly bond purchases from AUD5 billion to AUD4 billion.  This contraction in economic stimulus comes as Sydney, Australia’s largest city, and Melbourne have entered lockdowns. The delta variant outbreak is viewed by some as so serious that calls for steel fabricated rings be placed around the city of Melbourne, for example.

The RBA notes that Australia’s move toward economic recovery has been stymied by the delta outbreak.  In its August 2021 Statement on Monetary Policy, the RBA found that, “The near-term outlook is highly uncertain and dependent on health outcomes. Further large outbreaks are possible, but the need for extended lockdowns should diminish as vaccination coverage increases.  The longer the lockdowns continue, however, the more likely it is that jobs are lost.”

The RBA expects recent lockdowns to be less onerous on the economy when compared to lockdowns in the first half of last year.  This is because businesses have adjusted their models to compensate for changes in consumption.

Consumer price index (CPI) inflation was measured at 3.8% last June due in part to reversals in declining prices as the economy started an upward climb.  When volatile items such as petrol, fruits and vegetables are removed from the estimate, inflation was around 1.75%.

The RBA reported strengthening exports with increases in prices for its commodities.  The RBA noted that the AUD continues to depreciate in spite of high prices.  The RBA describes yields and spreads on corporate bonds and interest rates as low.

The RBA expects interest rates to continue on an upward path for advanced economies given bottlenecks in supply chains and rapid re-openings.  Interestingly, the RBA did not specify that such increases would happen in the Australian economy.

On the other hand, Australia may see increases in interest rates as it tapers its bond purchases.

As of 5 August, the yield on the Australian government 2-year bond was .03%.  Bloomberg reports two-year yields on U.S. Treasuries at 0.21%. As of 9:21 pm EST, Reuters reports the AUD/USD exchange rate at 0.7330 USD.

Alton Drew

For a consultation on any regulatory or legislative discussions or announcements, please reach out to us at altondrew@altondrew.com for information on consultation rates and to reserve an appointment.

Interbank market news scan: Foreign exchange rates as the markets enter Easter weekend and the American capitol sees another attack …

Politics. A motorist rammed a vehicle into U.S. Capitol police on Friday and brandished a knife, killing one officer and injuring another and forcing the Capitol complex to lock down in an attack that police said did not immediately appear to be terrorism-related. Police officer killed in vehicle attack on U.S. Capitol | Reuters

Currency PairsRates as of 4:11pm 2 April 2021
EUR/USD1.1762
AUD/USD0.7602
GBP/USD1.3821
USD/JPY110.6800
NZD/USD0.7018
USD/CHF0.9421
USD/NOK8.5278
USD/SEK8.7239
USD/CAD1.2568
  
Selected Rates 
Fed Funds.07
Bank prime rate3.25
Discount window.25
2-yr Treasury.19
10-yr Treasury1.72
30-yr2.36
Sources: Bloomberg, Reuters

Interbank market news scan: The equity markets in the US may be closed, but foreign exchange markets are not resting in light of an improving employment picture …

The U,S, Department of Labor today reported that non-farm payrolls increased in March by 916,000 employees while the unemployment rate fell to 6.0%. Employment gains were led buy the leisure and hospitality, public and private education, and construction sectors. THE EMPLOYMENT SITUATION — MARCH 2021 (dol.gov)

Currency PairsRates as of 9:19am 2 April 2021
EUR/USD1.1768
AUD/USD0.7614
GBP/USD1.3837
USD/JPY110.5800
NZD/USD0.7032
USD/CHF0.9409
USD/NOK8.5335
USD/SEK8.7131
USD/CAD1.2548
  
Selected Rates 
Fed Funds.07
Bank prime rate3.25
Discount window.25
2-yr Treasury.18
10-yr Treasury1.71
30-yr2.36
Sources: Reuters, Bloomberg