PIMCO paper on Central Banking ... and long term bond rates
This one is really a hat tip to Brad Setser for without him I would never have come to see this article (Paul McCulley and Andrew Balls from PIMCO bonds on 'Global Central Bank Focus) I imagine. Now, where Brad Setser's narrative on the contiuation of Bretton Woods 2 (in so very short; the continuing (Chinese) financing of the US CA deficit) is very interesting in itself we can also use this article for something else. The requirements are merely that you, like me at the moment, are mentally preoccupied with how central banking actually works and how forecasts are made. We can all pull down our textbooks from the shelves and get the most basic theories but as Brad also says we are perhaps not living in normal times. The PIMCO paper is defending Bernanke and this might be called for but try to read above and beyond that and you will get some interesting quotes and opinions on how central banks navigate as they do and why they sometimes face daunting tasks in doing so.
Let us begin with one of those definitions of central banking, and a good one I might add ...
'Central banking is the art and science of decision-making under uncertainty. Policymakers at the Fed and elsewhere must base interest rate decisions on their expectation of where the economy is going, not just where it has been. Monetary policy by necessity is explained by reference to the economic forecasts and a reaction to shocks.'
Add to the above the dynamics of market expectations and how they are driven by policy makers and you have the core issues of how to conduct central banking, at leas this is how it is presently viewed. Another important point seems to be that of Brad Setser's un-normal times which is narrated as the turn of the business cycle in the PIMCO paper.
'It is no surprise that monetary policy decisions are hardest to make, and to explain, when the economic and interest rate cycles are at a turning point. Alan Greenspan, you might say, got out just at the right time – and you can’t help wondering if he planned it that way! It is inevitable that in a period of “transition,” to use Mr. Bernanke’s phrase, that there will be tension between the incoming data and the forecast.'
We also get into some of the nitty-gritty choices of how to actually run a central bank ... core or headline inflation?
'Crucially for any central bank and particularly one prepared to focus on core inflation rather than headline inflation boosted by energy prices, inflation expectations must remain well contained – measured by the TIPS market or by the surveys.'
Or what about the question of transparency?
'The logic of Mr. Bernanke’s approach suggests that he will soon push for the Fed to start releasing the FOMC’s forecasts on a quarterly basis, rather than twice-yearly, and to keep them fresh. And for the forecasts to be truly useful, we believe the committee should make clearer the path for the Fed funds rate that committee members have in mind. Or if that is seen as too radical, the committee could use financial market expectations as the basis for the forecast, Bank of England style. In any event, it is clear enough from the statements and the minutes that whatever further rate increases the FOMC members were penciling in when coming up with their forecasts ahead of the June meeting, they were not assuming much more – if any – in the way of rate hikes.'
Moving on to the bottom line which, dare I say it, is almost Roubinish in its predictions albeit with an implicitly more optimistic view on how much the Fed can actually do to amend the slowing US economy.
'As the housing market rolls over, downside risks to growth must rise in importance in the eyes of responsible, forward-looking central bankers. With all due respect to Mae West, too much of a good thing is not always a good thing.
Indeed here at PIMCO we believe the Fed has already gone too far. That means it is likely to reverse course within the next 6-9 months, in line with past experience – even though this has been a very different cycle. As Bill Gross intoned in his August Investment Outlook, the Fed tightening-inspired bear market in bonds is over. A new bull market is underway.'
So what to do here; well read it that is for sure and begin with the narrative I have put fourth and if is not to your liking ... By all means, join Setser and the discussion of how and when to unwind those global imbalances and how this will affect the US bond market because this is oh so interesting to debate as well.