Rate Watch #753 Should the Dual Mandate Continue
December 17, 2010
by Dick Lepre
[email protected]
www.loanmine.com
Fundamentals
Leading Economic Indicators was +1.1% in November. I am thinking that some of this is a genuine increase in confidence from consumers but that some if this is simply because M2 money supply (which is driven up by QE) is a large factor in LEI. The presumption is that expanded M2 will not get stuck at the Fed as it did last time the Fed tried QE. We are, for example, still seeing a contraction in Consumer Credit. To some extent this is at the choice of consumers but to the extent than banks are still not willing to loan the almost-free money they are getting from the Fed, LEI may be overstating recovery.
These are the components of LEI and the weight given to each:
1 Average weekly hours, manufacturing 0.2725
2 Average weekly initial claims for unemployment insurance 0.0322
3 Manufacturers' new orders, consumer goods and materials 0.0809
4 Index of supplier deliveries – vendor performance 0.0715
5 Manufacturers' new orders, nondefense capital goods 0.0192
6 Building permits, new private housing units 0.0263
7 Stock prices, 500 common stocks 0.0373
8 Money supply, M2 0.3248
9 Interest rate spread, 10-year Treasury bonds less federal funds 0.1058
10 Index of consumer expectations 0.0295
M2 makes up 32.48% of LEI and Average Weekly Hours is 27.25%. If you have nothing better to do, here is a detailed explanation of LEI.
Initial Jobless Claims last week were 420,000 - slightly below consensus and previous.
Housing Starts were 555,000 annualized. Consensus was 545,000.
Building Permits were 530,000. Consensus was 560,000.
CPI was +0.1% overall and core. These data continue the years long period of seeing higher increases in PPI (wholesale costs) and smaller increases in CPI. Industrial Production and Capacity Utilization were both higher.
Core PPI: 0.3%, consensus was 0.2%, previous was -0.6%
Overall PPI: 0.8%, consensus was 0.5%, previous 0.4%
Retail Sales ex-auto: 1.2%, consensus was 0.6%, previous was 0.4%
Retail Sales overall: 0.8%, consensus was 0.5%, previous was 1.2%
The Technicals
The daily is bearish (lower prices, higher yields), the weekly is bearish and the monthly while not actually bearish is clearly about to turn bearish. This market is so oversold that we are seeing a technical correction starting today. This will probably get the 10 year yield back to something near 3.1%. This is a Christmas gift which will last less than 2 weeks. The longer term picture is still bearish.
Jim Grauer (StoMaster) has started updating his comments about the bond tech almost every day. Check it out at StoMaster. This is complex stuff. You need to keep in mind that this is a technical analysis which deliberately blinds itself to economic fundamentals and looks only at the data (30 year Treasury bond futures.) This technical analysis is presented here because I believe that it supplements analysis of fundamentals.
Analysis
The Fed announced this week that it would continue its QE buying of Treasuries. Presumably the Fed's intention was to keep Treasury yields low but precisely the opposite is happening. Investors (or whatever you want to call the folks selling Treasuries) are thinking that QE will cause inflation. Mortgage rates have shot up because investors are betting that the Fed is inciting inflation.
FNMA will keep the current conforming and high-balance conforming loan limits in place for loans funded before September 30, 2011. After that, the high-balance conforming will be cut back (as word fail me here) to the permanent temporary limit of $625,500.
A list of the high-balance limits by county may be found here by selecting the state from the pull-down and typing the county.
Dual Mandate
Last week I wrote at length about the role of the Federal Reserve in preventing a much worse set of consequences from the liquidity crisis. That served as a reminder that the first task of the Fed is the preservation of the health of the banking system. Since events such as the liquidity crisis are rare the move usual role of the Fed is described as a dual mandate. The dual mandate was formally established by a series of Congressional acts starting with the Full Employment Act of 1946 going through the Humphrey–Hawkins Full Employment Act of 1978. Humphrey–Hawkins occurred in the context of rising unemployment in the late 1970's. This is what the Unemployment rate was in the period 1974-1988.
| Year | Jan | Feb | Mar | Apr | May | Jun | Jul | Aug | Sep | Oct | Nov | Dec |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| 1974 | 5.1 | 5.2 | 5.1 | 5.1 | 5.1 | 5.4 | 5.5 | 5.5 | 5.9 | 6.0 | 6.6 | 7.2 |
| 1975 | 8.1 | 8.1 | 8.6 | 8.8 | 9.0 | 8.8 | 8.6 | 8.4 | 8.4 | 8.4 | 8.3 | 8.2 |
| 1976 | 7.9 | 7.7 | 7.6 | 7.7 | 7.4 | 7.6 | 7.8 | 7.8 | 7.6 | 7.7 | 7.8 | 7.8 |
| 1977 | 7.5 | 7.6 | 7.4 | 7.2 | 7.0 | 7.2 | 6.9 | 7.0 | 6.8 | 6.8 | 6.8 | 6.4 |
| 1978 | 6.4 | 6.3 | 6.3 | 6.1 | 6.0 | 5.9 | 6.2 | 5.9 | 6.0 | 5.8 | 5.9 | 6.0 |
| 1979 | 5.9 | 5.9 | 5.8 | 5.8 | 5.6 | 5.7 | 5.7 | 6.0 | 5.9 | 6.0 | 5.9 | 6.0 |
| 1980 | 6.3 | 6.3 | 6.3 | 6.9 | 7.5 | 7.6 | 7.8 | 7.7 | 7.5 | 7.5 | 7.5 | 7.2 |
| 1981 | 7.5 | 7.4 | 7.4 | 7.2 | 7.5 | 7.5 | 7.2 | 7.4 | 7.6 | 7.9 | 8.3 | 8.5 |
| 1982 | 8.6 | 8.9 | 9.0 | 9.3 | 9.4 | 9.6 | 9.8 | 9.8 | 10.1 | 10.4 | 10.8 | 10.8 |
| 1983 | 10.4 | 10.4 | 10.3 | 10.2 | 10.1 | 10.1 | 9.4 | 9.5 | 9.2 | 8.8 | 8.5 | 8.3 |
| 1984 | 8.0 | 7.8 | 7.8 | 7.7 | 7.4 | 7.2 | 7.5 | 7.5 | 7.3 | 7.4 | 7.2 | 7.3 |
| 1985 | 7.3 | 7.2 | 7.2 | 7.3 | 7.2 | 7.4 | 7.4 | 7.1 | 7.1 | 7.1 | 7.0 | 7.0 |
| 1986 | 6.7 | 7.2 | 7.2 | 7.1 | 7.2 | 7.2 | 7.0 | 6.9 | 7.0 | 7.0 | 6.9 | 6.6 |
| 1987 | 6.6 | 6.6 | 6.6 | 6.3 | 6.3 | 6.2 | 6.1 | 6.0 | 5.9 | 6.0 | 5.8 | 5.7 |
| 1988 | 5.7 | 5.7 | 5.7 | 5.4 | 5.6 | 5.4 | 5.4 | 5.6 | 5.4 | 5.4 | 5.3 | 5.3 |
The goals of Humphrey-Hawkins were, in context of today's economic picture, naive. They were
- Explicitly state that the federal government will rely primarily on private enterprise to achieve the goals.
- Instructs the government to take reasonable means to balance the budget.
- Instructs the government to establish a balance of trade, i.e., to avoid trade surpluses or deficits.
- Full employment
Humphery-Hawkins set specific numerical goals for the President to attain. By 1983, unemployment rates should be not more than 3% for persons aged 20 or over and not more than 4% for persons aged 16 or over, and inflation rates should not be over 4%. By 1988, inflation rates should be 0%. The Act allows Congress to revise these goals over time. H-H also stated: If private enterprise appears not to be meeting these goals, the Act expressly allows the government to create a "reservoir of public employment." These jobs are required to be in the lower ranges of skill and pay to minimize competition with the private sector.
Now that we are done laughing let's consider the dual mandate. Humphrey-Hawkins (and its predecessors) mandated that the Board of Governors of the Federal Reserve establish a monetary policy that maintains long-run growth and promotes price stability. The question open for discussion at present is very simple: is it possible for the Fed to act in the best interests of the economy if it pursues this dual mandate or should the mandate of the Fed be solely to contain inflation.
The question might be rephrased as this: might it be the case that by asking the Fed to accomplish these two tasks they actually accomplish neither and, consequently, might we be better off it we gave them one single goal and they targeted that?
Why does the Fed have a dual mandate? It was though that if the Fed acted to decrease unemployment it would cause inflation. This was the NAIRU notion. (Read my old post of 1998 RateWatch #94) NAIRU was the belief that low unemployment inevitably caused inflation. When we were in the midst of the great time generated by the Internet boom we had unemployment right around 4.0% and CPI was contained below +2.5% that year. Was this an anomaly or perhaps is it the case that the global economy acted as an inflation suppressing force even with such low unemployment?
Economists formulate theories and notions in response to what was. The idea that low domestic unemployment would inevitably cause inflation was a simple case of supply/demand market economics. The problem was that with world markets opened it was no longer the case that low domestic unemployment acted to incite inflation. Outsourcing of white collar jobs was enabled by the expansion of the Internet and low cost telecommunications. NAIRU was irrelevant.
So if we can have low unemployment without having high inflation should we dump the dual mandate and simply let the Fed have the simple mandate most relevant to its role as keeper of monetary policy and direct it to only contain inflation.
Presumably low unemployment is in the interest of everyone and business has all the incentive it needs to create millions and millions of jobs.
It would appear to be the case at present that the Fed is pursuing the wrong side of its mandate by using QE as a stimulus and not paying enough attention to possible inflationary consequences.
The fact is that as the monetary authority the Fed is best positioned to deal with inflation. Economic growth is generated by innovations from businesses and individuals aided by capital markets. Fiscal policy can help economic growth but the idea that when nothing is working we must turn to the Fed for growth may have long-term adverse effects. The worst case is that we generate inflation and little or no growth - stagflation. The Fed did its part by lowering rates.
If you have something to add to this discussion please post a comment on the blog.
Dick Lepre
RPM - SF
1400 Van Ness Avenue
San Francisco, CA 94109
DRE License # 01143973
[email protected]
Web site: www.loanmine.com
Blog: economy.typepad.com
(415) 244-9383
(866) 488-2051 fax
California Department of Real Estate - real estate broker license #01201643
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