IMF Is Doing The Fed’s Job

June 29, 2015 0 Comments

Lagarde has her hands full as Director of the International Monetary Fund. In light of the mess that Greece has gotten itself into (thanks to the persistence of Prime Minister Alex Tsipras) you would think that she would have much better things to do, but she some has the time to tell Janet Yellen how to fix her economy.

Then again, its not as if she doesn’t need the help. Although the contraction in the economy last quarter was less than anticipated, targeted growth isn’t where it should be. With economy growth still weak, the IMF has encouraged the Federal Reserve to delay their rate hikes until the first half of 2016 and reduce their 2015 growth outlook from 3.1% to 2.5%.

For the last 6 years, the economy has been growing at a average annualized rate of 2.2%. So 2.5% is still above average, but not by a significant amount.

Considering how vested Lagarde has gotten into the affairs of the Federal Reserve, it would probably be better if Yellen simply moved her office inside IMF headquarters.

This year we have also undertaken a Financial Sector Assessment Program with the United States. We conduct these once every 5 years for systemically important countries and it is a comprehensive exercise looking at the whole U.S. financial system.

Given this important work, we have focused our review of the U.S. economy on financial stability risks and the appropriate policies to mitigate them, as well as looking at recent movements in the U.S. dollar and the timing, form, and impact of interest rate normalization by the Fed.

A more detailed report on the U.S. economy and on the financial sector will be available on July 8.

Yet again, the review took place against the background of a shaky first quarter for the U.S. economy. And we revised our growth forecast down to 2.5 percent for 2015. This is largely due to those factors that affected the first quarter.

But this is not our main message. Our main point is that we still believe that the underpinnings for a continued expansion are in place. The labor market has steadily improved over the last year—job growth has averaged about 250,000 per month— and financial conditions remain very accommodative. Moreover, we expect cheaper oil prices to boost consumption in the remainder of 2015, although lower oil prices is going to continue taking a bite out of oil-related investment, as we saw in the first quarter.

As always, there are risks and uncertainties to the outlook. For example, further delay of the housing recovery and the strong dollar—notwithstanding the latest improvement in the trade balance—could be a drag on future growth. Nevertheless, when we look at the whole picture, we believe that growth in the coming quarters will be 3 percent or higher.

We see inflation pressures as muted. Long-term unemployment and high levels of part-time work both point to remaining employment slack. Wage indicators on the whole have shown only tepid growth. When combined with dollar appreciation and cheaper energy costs, we expect inflation to start rising later in the year, but only slowly, reaching the Federal Reserve’s 2 percent medium-term objective by mid 2017.

Over the medium term, as we highlighted last year, there is still much work to be done. Our forecasts of potential growth are now around 2 percent—a far cry from the over 3 percent average growth rates we saw before the Great Recession.
In conclusion:

  • We believe near-term U.S. growth prospects are good.
  • It is better to wait for stronger signs of inflation pressures and have an interest rate hike in the first half of 2016.
  • Even after the initial step to raise rates, a gradual rise in the federal funds rate will likely be appropriate.
  • And although important progress has been made to strengthen the U.S. financial system, there is more to be done to address the pockets of vulnerability.

And more “unsolicited advice” from Christine Lagarde: Janet Yellen should get rid of the dots.

I guess I should explain the dots before I continue. They’re merely a chart that forecast when the Federal Reserve will make their first rate hike, and how far they believe they will go at the end of the year. Here would be an example of that dot plot for 2015 – 2017:

Each dot represents a member of the Federal Open Market Committee (FOMC), and their plots represent where they believe the end of the year target will be for interest rates. According to the chart, the median target for rates are somewhere between 0.75% and 1%.

This is a really aggressive, because 1) we are more than halfway through the year 2015 already and there isn’t a rate hike and 2) members of the FOMC have hinted at smaller rate hikes of somewhere between 0.25% and 0.50%. However, the majority of the FOMC believe that rates will be between 0.50% and 0.75% by years’ end.

So why does the IMF hate these dots so much? Well, it’s not so much that the IMF hates the dots, but rather that it fails to provide a clear vision of the direction the Fed is likely to go. The IMF isn’t exactly along in this, as the dots has plenty of other critics as well. One of the other problems pertaining to the dots involves the fact that there is no clear picture on who represents the majority view of the FOMC.

For example, we know that majority of members believe that rates will be set between 0.50% and 0.75% by the end of the year. We don’t exactly know which members of the FOMC support this forecast. It could be anyone from Janet Yellen to Dennis Lockhart. This could lead to many communication errors between the Federal Reserve and the markets.

Whereas some investors and market analyst look at the dots as if they were reading tea leaves, other investors disregard them altogether, such as Peter Boockvar of The Lindsey Group:

As some of the dot plot estimates are from members that won’t be voting, I don’t pay much attention to the dots as listening to Yellen, Fischer and Dudley is the only thing important in gauging the future direction and pace of interest rates.

Personally, I think dots are useful in specific time periods of monetary policy. In times during Zero Lower Bound (like right now) I think the dots can be useful. As we transition from new zero interest rates into a more normalized monetary policy, the dots can be considered unnecessary.

The IMF has expressed a desire to eliminate the dots altogether in favor of single forecast report, similar to what the ECB does on occasion. Whether or not the market believes the dots are useful is up for determination, but for now, we are stuck with them.

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