MilePost: Top of the Street

Wall Street, the Federal Reserve and others produce a constant flow of research and opinion. Some of the best recent efforts:

The movie plays on: a lens for viewing the global economy
Claudio Borio, BIS
10 February 2016

In trying to diagnose why the global economy seems unable to return to sustainable, balanced growth, the head of the monetary and economic department at the BIS attributes it to just a few influences – high debt and low productivity, an evolving but still poor understanding of the problem and chronic high risk around the world.

Financial imbalances keep showing up all over the place and policymakers can’t seem to counter them, Borio argues. Debt is too high. In advanced economies, growth in government debt has more than offset any drop in private. In emerging economies, private debt outside of the banking system has doubled as a share of GDP while borrowers’ profitability has dropped by two thirds. Productivity growth has declined in the mean time, so globally we may not be able to grow our way out of the debt load. Policy makers may not be able to help as much as in the past. Fiscal policy is limited by high debt and monetary policy by low rates and ballooning balance sheets.

We need a new framework for thinking about the problem and the right response, Borio continues. We need to recognize a financial cycle, a cycle of credit and property booms and busts that reinforce business cycles. Here Borio echoes a broad set of ideas about pro-cyclical lending. Financial cycles cut output and productivity mainly by misallocating capital during booms to the leveraged sectors of the economy. Financial cycles have become bigger since the 1980s because of deregulation and, along with globalization, have made it harder to manage monetary policy.

From Borio’s seat at the central bankers’ bank, he sees lot of risk: more financial distress, chronic instability and weakness. And he worries about pressure on the consensus supporting open global economies.

Meeting the low bar
Jan Hatzius, Jari Stehn and Karen Reichgott, Goldman Sachs
19 February 2016

Real GDP growth has consistently fallen short of expectations since the 2008 financial crisis, and Hatzius and his team argue that a new lower rate of potential growth could raise US inflation in the near term.

Inflation has stayed low for years even as the labor market has tightened, pointing to a drop in the rate at which the economy can expand. That potential rate of growth depends on the flow of labor into the economy and its rate of productivity. Hatzius and colleagues measure this potential rate of growth and conclude that the US, among other countries, is getting close to its potential. Even if potential growth is much lower than before the 2008 financial crisis, the gap between realized and potential is narrowing. For the fixed income markets, this argues that inflation should rise if the economy hits and then exceeds that potential.

Since Hatzius and his colleagues use tools similar to those used in Fed circles, this potentially shines light onto the view of the economy held at the Fed. The Fed clearly sees financial pressures, but possibly a narrow output gap. That may explain the Fed’s hesitation to substantially revise their bias to pushing rates up.

Are tighter financial conditions a harbinger of a US growth slowdown?
Peter Hooper, Michael Spencer, Torsten Slok and Matthew Luzzetti, Deutsche Bank
17 February 2016

Tighter financial conditions clearly have the attention of the Fed and the constellation of economists around them, and Deutsche Bank weighs in with its latest view. The DB index along with ones published by Goldman Sachs, Bloomberg, the US Monetary Policy Forum and the Kansas City Fed all show a sharp 1Q16 rise in the cost of capital.

DB gives some color on the underlying details – falling equity prices, wider credit spreads and higher volatility all tightening conditions, lower oil prices and interest rates working to loosen them.

DB also gives some perspective on how frequently a tightening of conditions has preceded a slowdown in US growth. They resist Paul Samuelson’s quip that Wall Street has predicted nine of the last five recessions.

The piece does argue that the tighter conditions as seen so far will likely slow growth in 1Q16 and 2Q16.  Whether the drag carries over into the second half of the year depends on whether tight conditions persist.

MBS: Negative sentiment
US Fixed Income Markets Weekly
Matt Jozoff, Nicholas Macinunas, Brian Ye and Alexander Kraus, JP Morgan
19 February 2016

Negative rates in Europe and Japan have come as an unpleasant surprise for investors in securities whose coupons float without a floor on the rate, but MBS does not have this problem. A range of MBS has floating coupons – some CMOs and all ARMs – but all have a floor on the rate set at zero. These authors lay out the details of a detail that suddenly matters in a world of negative rates.