Carney's Dilemma

There are enough studies on the term structure to pave the way, as they often say, “from here to the moon.”   And that would be limited to central bank studies. Private studies would take us right out of the solar system (along with Voyager I).

We have specialized past years in term-structure strategy, the US and UK. Results have been satisfactory. We don’t examine the yield curve with scholastic rigor so much as common sense. But central banks, including Carney’s Bank of England rely on the “expectations model” of the term structure.  This forms, as John Taylor explains, the theoretical underpinning of so-called forward guidance. It’s a weak theory, explaining why for example Carney at this very moment is perplexed at the long end’s reaction to his preaching.

Perceived central bank generosity in the face of 1) surprising economic vigor and, 2) elevated price reads means corrosion in long-end debt prices. That’s the situation in the UK after Carney’s maiden speech today.


Robert Craven

Meddling - Never a Good Idea

We predicted in earlier posts that UK real-sector activity would flatten estimates, especially in services and manufacturing; that economists were driving full speed ahead with their eyes in the rear-view mirror. Most of these types are now extracting themselves from the wreckage.  And yet just a day or two after Manufacturing, Construction and Service reads all blew through consensus, Carney explained to the market crowd that he will keep the base rate very low (0.5%) until unemployment touches 7%!  Inflation last print at 2.8% was apparently not a problem. And then just following Carney’s announcement, both Jobs and Consumer data likewise flattened estimates.  Naturally, gilts have tanked. 

Key – central bankers rarely understand FI price determination, the workings of the auction market. This was especially true with Greenspan, is true with Bernanke and apparently true with Carney.  It is how and why they can get themselves in a lot of trouble.  

However – and this is a really big “however” - the skill or instinct to predict FI price change is not a requirement for the chair to be successful. Any chair can stay out of trouble given he has a lick of sense. To be successful the chair must function under some rule of order; that is, policy fixed for all to understand.  When the chair invents policy with all sorts of escape clauses and bells and whistles, as Carney has, and then compounds the problem by attempting to communicate through the noise and bullets, then that chair has stepped right into it.

Best would have been to stick with a 2% target but no, that was too easy.

Just ahead: Although she’s come along nicely, the UK economy has a few more pleasant surprises in store.  Gilt prices will ease further. Carney will then hint at more QE. Sterling will tank. And even if it doesn’t the Bank’s buying of a few long bonds will not stop the hemorrhaging. That is not the way things will work. Gilt prices will erode still further. This will retard economic momentum or even stop it dead in its tracks. 


Robert Craven
 

Gone Fishing

A rule of law allows individuals living in an open society to know the limits of behavior up front; these rules are fixed (unless changed by popular consent) and so provide an environment free of interference and prejudice from government. Players know the rules and conduct themselves accordingly.

A rule of monetary guidance is also required; required that is for an economy to thrive. Players will remain at the sidelines without it.  Hiring wilts when economic policy is discretionary, variable, and uncertain. Don’t believe us?  See the study Uncertainty and the Slow Labor Market Recovery by Leduc and Liu, SF Fed. On second thought - you don’t need to do that; it’s intuitive for goodness sake.

We do not have a simple rule of guidance in the US (nor does the UK now that Carney has changed the rules).  As a result, this “recovery” pales compared to a real one. Growth the past four quarters has been pathetic, not the 5.2% average four year growth of the 80’s recovery.  Why?  Risk takers have quailed.

There is hope however in the person of Don Kohn, a candidate for Fed chair.  Don, unlike Yellen or Summers, understands the benefits of non-interventionist central banking. Fingers crossed.

Finally, what about transmission to the bottom line, over the near term? Those interested in anticipating FI price change must buy a ticket to the carnival. It is no longer one’s view for near-term real sector change that matters, it is instead what one planner – Bernanke - expects regarding near-term change in the economy; but not even that – it is what the market crowd thinks that Bernanke the barker will think about near-term change in the economy and, what discretionary tool he may next pull out of his hat. That is why so many able folk have gone fishing.

Speaking of gone fishing, my granddaughter of 4 recently pulled a big brown trout out of a WA state lake with her 4’ pink fishing rod, a lake where supposedly no brown existed – only carp and bluegill. Her Dad helped a tad, but mostly got in the way.


Robert Craven

Always Look for the Flaw

We’ve omitted the UK for several weeks, for the simple reason we’ve had nothing new to contribute.

April/4 we noted that we had identified a flaw common to most economic models, so that there would be an under-shoot to key releases, and particularly an under-shoot to 1) private services and 2) manufacturing. With the July manuf PMI at a 28 month high, and with today’s PMI Services report at the fastest pace since records began (1998) and blowing through all estimates, that insight translated satisfactorily.

Key to those interested in capturing FI price change is to understand where the majority of observers have gone wrong; that is, the Achilles heel to most models.  That is our method.

Next, our sketch of Apr/23 – Stay With It George – resulted in outrage; half a dozen or so of our readers demanded they be immediately redacted from our distribution list and never, ever wanted to hear from us again. Darn. Yet we do have an enlightened administration, or as we wrote Apr/23, compared to that which went before. This administration has had the courage to cut spending; it is the revenue side –  tagged to a recovery, which is lagging; yet that won’t be for long given that we have been right about the UK.


Robert Craven