Wednesday, June 1, 2011

Fed Funds and Aggregate Demand Watch 6/1/2011 : Expectations Continue to Fall




S&P 500
April 27 : 1357
May 26 : 1325.69
June 1: 1314.55

Treasuries
2 year
April 27: 0.64
May 26 : 0.48
June 1: 0.44
10 Year
April 27 : 3.35
May 26 : 3.06
June 1: 2.95
30 Year
April 27 : 4.45
May 26 : 4.22
June 1: 4.14

Inflation Expectations
2 year inflation swaps
April 27 : 2.65
May 26 : 2.12
June 1: 2.05
5 Year TIPS Breakeven rate
April 27 : 2.35
May 26 : 2.07
June 1: 2.01
10 Year TIPS spread
April 27 : 2.6
May 26 : 2.34
June 1: 2.28
30 Year TIPS spread
April 27 : 2.68
May 26 : 2.47
June 1: 2.42

Bloomberg Commodity Index
April 27 : 1766.98
May 26 : 1684.28
June 1: 1691.51

EUR USD
April 27 : 1.4738
May 26 : 1.4129
June 1: 1.4329

(Data from bloomberg.com)

It's amazing how quickly things have gone down the drain since Bernanke's press conference. A lot of press coverage has focused on how the earthquake in Japan may be behind some of the disappointing economic data, but markets are signaling that longer term expectations have fallen as well.

Lower Fed Fund futures expectations, stock prices, bond yields, exchange rates, commodity prices, and inflation expectations are all signs of tighter monetary policy. Lower fed funds rates and treasury yields signaling tighter money may sound counter-intuitive, but the Fed won't raise rates until the economy is in better shape, and lower treasury yields reflect lower inflation and real growth expectations.

I hereby predict that 
1) Economic data will continue to get worse until the Fed intervenes in some manner. Markets have already priced in some response by the Fed, but every day without intervention will drive markets down further. Markets are waiting for easier money. (Translation: tight money is the economy's biggest problem)
2) Regardless of how the Fed intervenes, the direction of economic activity will quickly turn around, although the magnitude of the recovery depends on what method the Fed chooses in it's intervention (Translation : monetary policy doesn't have long and variable lags to the extent it is commonly believed)
3) Any kind of a long term anchor (explicit NGDP/CPI targeting) or adjustable policy (changing IOR or asset purchases monthly based on the latest data) will be more effective  than ambiguous and rigid policies (QE2, keeping the Fed Funds rate at 0% for "an extended period of time") (Translation: Monetary policy needs to commit to changing along with the state of the economy to be effective. It's not clear what rates of inflation the Fed is willing to put up with and what the Fed is willing to do to make sure it reaches its goals)

These are all verifiable predictions. We'll see how they do!

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