Our Boring Universe

Matt O'brien (@obsoletedogma ) posts consistently thought provoking articles for The Atlantic. This post from Friday on FED QE effectiveness is a good example.

The 2% Mystery: Why Has QE3 Been Such a Bust?

This chart is the meat of the post which we encourage you to read and credit Matt O'Brien for:5BreaksFed1

Unlike earlier pedestrian critiques of QE that erroneously measured efficacy with pictures of equity market advances, the B/E metric is an accurate data point to steer by. However, I am less convinced (hence the lead video) that the interpretation is correct. The chart shows that deflationary pressure has declined and/or been mitigated with every QE advance. More importantly, the Spring 2012 EU collapse did not break the 3 year trend of higher inflationary lows (Twist on graph). We have put forth on several previous occasions that we attribute this to the PROCESS (flow) of QE rather than the LEVEL (stock) of balance sheet. Like MMT cultists, the prescription is to just "Do more" [here raise the inflation target to 3] and voila Goldilocks.

We can hold the fact that the B/E curve also structures into forwards and thus adjusts in shape for a later time. We would like to focus on the black line of 2%. If, as some believe, the market is adjusting to target (and Japan is finally moving this way to 1% as Ed Bradford { @Fullcarry} nicely shows) as in an interest rate regime to FF, then Fed QE is actually a resounding success.

I would argue, as I did under interest rate targeting and again under QE, that if the compass metric is flawed the economic ship can be off course. For example, in an interest rate regime 4% can be "too tight" or "too loose" depending upon other variables. Those variables can remain unknown for significant periods of real time, thus rendering the Taylor Rule weak. I developed an Equilibrium Model for FF that measures market prices against the rate of a neutral (Fed neither easy or tight) policy. Put simply, where would the rate be if the market could set it? Our data show that the breaks associated with Fed efficacy correspond with recent periods of Fed equilibrium (NEUTRALITY) tilting toward "tightness". The present reading, unlike the Taylor Rule's -5%, is 16bp - roughly spot on the Fed objective and solidifying the Inflation expectations presented in the graphic. The consequence, for both Policy Bears (h/t @Mark_Dow ) and the economy is the Fed is NOT nearly as easy as many are inclined to believe.

This is what the policy Holy Grail of stability feels/looks like. A command and control approach to monetary policy creates a brittle system. The post crisis economic retrenchments are considerably  less severe, yet more frequent, a characteristic also common to Pre-Credit Super Cycle time periods.  Are expectations solidifying around the target because the Fed has suppressed the ability to move away from them? Is the 10 year nominal rate lower - and if so by how much - than a free market would price it? Or, have we returned to rates commonly associated with long periods of history (See Sydney Homer) prior to the 70's-80s experience. Lets call it The Great Mean Reversion. The MOVE, the VIX, the TED, the national mood all reflect this bear market in chaos. Aggressively held opinions away from the boring reality are promulgated to fill the 24 hour television coverage and vast internet bandwidth wasteland. The blanket hugging Linus's waiting in the cold for The Great Rotation the most recent example of hoped for action. Someday something is bound to happen somewhere, we're ready and waiting...and I'll believe it when (if) I see it.

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