New Nonfarm Hires of 6.343 Million in Jul 2020, New 2.421 Million Full-Time Jobs Created in August 2020, Recovery Without Hiring in the Lost Economic Cycle of the Global Recession with Economic Growth Underperforming Below Trend Worldwide, Fifteen Million Fewer Full-Time Jobs In the Global Recession, with Output in the US Reaching a High in Feb 2020 (https://www.nber.org/cycles.html), in the Lockdown of Economic Activity in the COVID-19 Event, Youth and Middle-Age Unemployment, United States Inflation, World Cyclical Slow Growth, and Government Intervention in Globalization: Part VI

 

Carlos M. Pelaez

 

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019, 2020.

 

I Recovery without Hiring

IA1 Hiring Collapse

IA2 Labor Underutilization

            ICA3 Fifteen Million Fewer Full-time Jobs

IA4 Theory and Reality of Cyclical Slow Growth Not Secular Stagnation: Youth and Middle-Age Unemployment

IC United States Inflation

IC Long-term US Inflation

ID Current US Inflation

III World Financial Turbulence

IV Global Inflation

V World Economic Slowdown

VA United States

VB Japan

VC China

VD Euro Area

VE Germany

VF France

VG Italy

VH United Kingdom

VI Valuation of Risk Financial Assets

VII Economic Indicators

VIII Interest Rates

IX Conclusion

References

Appendixes

Appendix I The Great Inflation

IIIB Appendix on Safe Haven Currencies

IIIC Appendix on Fiscal Compact

IIID Appendix on European Central Bank Large Scale Lender of Last Resort

IIIG Appendix on Deficit Financing of Growth and the Debt Crisis

 

Table III-1, updated with every comment in this blog, provides beginning values on Sep 4 and daily values throughout the week ending on Sep 11, 2020, of various financial assets. Section VI Valuation of Risk Financial Assets provides a set of more complete values. All data are for New York time at the close of business. The first column provides the value on Fri Sep 4, 2020 and the percentage change in that prior week below the label of the financial risk asset. For example, the first column “Fri Sep 4, 2020,” first row “USD/EUR 1.1841  0.6%  0.1%,” provides the information that the US dollar (USD) appreciated 0.6 percent to USD 1.1841/EUR in the week ending on Sep 4 relative to the exchange rate on Aug 28 and appreciated 0.1 percent relative to Thu Sep 3. The first five asset rows provide five key exchange rates versus the dollar and the percentage cumulative appreciation (positive change or no sign) or depreciation (negative change or negative sign). Positive changes constitute appreciation of the relevant exchange rate and negative changes depreciation. Financial turbulence has been dominated by reactions to the new program for Greece (see section IB in https://cmpassocregulationblog.blogspot.com/2011/07/debt-and-financial-risk-aversion-and.html), modifications and new approach adopted in the Euro Summit of Oct 26 (European Commission 2011Oct26SS, 2011Oct26MRES), doubts on the larger countries in the euro zone with sovereign risks such as Spain and Italy but expanding into possibly France and Germany, the growth standstill recession and long-term unsustainable government debt in the US, worldwide deceleration of economic growth and continuing waves of inflation. An important current shock is that resulting from the agreement by European leaders at their meeting on Dec 9 (European Council 2911Dec9), which is analyzed in IIIC Appendix on Fiscal Compact. European leaders reached a new agreement on Jan 30 (https://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/127631.pdf) and another agreement on Jun 29, 2012 (https://www.consilium.europa.eu/uedocs/cms_data/docs/pressdata/en/ec/131388.pdf). There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). The most important source of financial turbulence is shifting toward fluctuating interest rates in the global recession, with output in the US reaching a high in Feb 2020 (https://www.nber.org/cycles.html), in the lockdown of economic activity in the COVID-19 event. The dollar/euro rate is quoted as number of US dollars USD per euro EUR, USD 1.1841/EUR in the first row, first column in the block for currencies in Table III-1 for Sep 4, appreciating to USD 1.1816/EUR on Mon Sep 7, 2020, or by 0.2 percent. The dollar appreciated because fewer dollars, $1.1816, were required on Mon Sep 7 to buy one euro than $1.1841 on Fri Sep 4. Table III-1 defines a country’s exchange rate as number of units of domestic currency per unit of foreign currency. USD/EUR would be the definition of the exchange rate of the US and the inverse [1/(USD/EUR)] is the definition in this convention of the rate of exchange of the euro zone, EUR/USD. A convention used throughout this blog is required to maintain consistency in characterizing movements of the exchange rate such as in Table III-1 as appreciation and depreciation. The first row for each of the currencies shows the market closing exchange rate at New York time, such as USD 1.1841/EUR on Sep 4. The second row provides the cumulative percentage appreciation or depreciation of the exchange rate from the rate on the last business day of the prior week, in this case Sep 4, to the last business day of the current week, in this case Sep 11, such as depreciation of 0.1 percent to USD 1.1848/EUR by Sep 11. The third row provides the percentage change from the prior business day to the current business day. For example, the USD depreciated (denoted by negative sign) by 0.1 percent from the rate of USD 1.1841/EUR on Fri Sep 4 to the rate of USD 1.1848 on Sep 11 {[(1.1848/1.1841) - 1]100 = 0.1%}. The dollar depreciated (denoted by negative sign) by 0.3 percent from the rate of USD 1.1816 on Thu Sep 10 to USD 1.1848/EUR on Fri Sep 11 {[(1.1848/1.1816) -1]100 = 0.3%}. Other factors constant, increasing risk aversion causes appreciation of the dollar relative to the euro, with rising uncertainty on European and global sovereign risks increasing dollar-denominated assets with sales of risk financial investments. On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues.

Chart III-1C provides the yields of the ten-year, two-year, one-month Treasury Constant Maturity, and the overnight Fed funds rate from Jan 2, 1962 to Sep 10, 2020. The final data point is for Sep 10, 2020 with the Fed funds rate at 0.09 percent, the one-month Treasury constant

maturity at 0.10 percent, the two-year at 0.14 percent and the ten-year at 0.68 percent. The causes of the financial crisis and global recession were interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero-interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash. The yields of Treasury securities inverted on Mar 22, 2019 with the ten-year yield at 2.44 percent below those of 2.49 percent for one-month, 2.48 percent for two months, 2.46 percent for three months, 2.48 percent for six months and 2.45 percent for one year (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). There was some flattening on Mar 29, 2019, with the 10-year at 2.41 percent, the 1-month at 2.43 percent, the 3-month at 2.40 percent, the 6-month at 2.44 percent and the 1-year at 2.40 percent. There was further mild steepening on Apr 12, 2019, with the 10-year at 2.568 percent, the 1-month at 2.419 percent, the 3-month at 2.440 percent, the 6-month at 2.463 percent and the 1-year at 2.453 percent. The final segment after 2001 shows the effects of unconventional monetary policy of extremely low, below inflation fed funds rate in lowering yields. This was an important cause of the global recession and financial crisis inducing as analyzed by Taylor (2018Oct 19, 2) “search for yield, excessive risk taking, a boom and bust in the housing market, and eventually the financial crisis and recession.” Monetary policy deviated from the Taylor Rule (Taylor 2018Oct19 see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2019Oct19 and  http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html)). An explanation is in the research of Adrian, Estrella and Shin (2018, 21-22): “Our findings suggest that the monetary tightening of 2004-2006 period ultimately did achieve a slowdown in real activity not because of its impact on the level of longer term interest rates, but rather because of its impact on the slope of the yield curve. In fact, while the level of the 10-year yield only increased 38 basis points between June 2004 and 2006, the term spread declined 325 basis points (from 3.44 to .19 percent). The fact that the slope flattened meant that intermediary profitability was compressed, thus shifting the supply of credit, and hence inducing changes in real activity. The 18 month lag between the end of the tightening cycle, and the beginning of the recession is perfectly compatible with effective monetary tightening.” See (https://www.newyorkfed.org/research/capital_markets/ycfaq.html). A major difference in the current cycle is the balance sheet of the Fed with purchases used to lower interest rates in specific segments and maturities such as mortgage-backed securities and longer terms.

Chart III-1C, Yield US Ten-Year, Two-Year and One-Month Treasury Constant Maturity Yields and Overnight Fed Funds Rate, Jan 3, 1962-Sep 10, 2020

Note: US Recessions in shaded areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/releases/h15/

There is mixed performance in equity indexes with several indexes in Table III-1 oscillating sharply in the week ending on Sep 11, 2020, after wide swings caused by reallocations of investment portfolios worldwide. The global recession, with output in the US reaching a high in Feb 2020 (https://www.nber.org/cycles.html), in the lockdown of economic activity in the COVID-19 event, is having strong effects in the economy and financial markets. Stagnating revenues, corporate cash hoarding, effects of currency oscillations on corporate earnings and declining investment are causing reevaluation of discounted net earnings with deteriorating views on the world economy and United States fiscal sustainability but investors have been driving indexes higher. There are complex economic, financial and political effects of the withdrawal of the UK from the European Union or BREXIT after the referendum on Jun 23, 2016 (https://next.ft.com/eu-referendum for extensive coverage by the Financial Times). Nuclear conflicts in the Korean Peninsula and global geopolitics are also affecting financial markets. An immediate factor is the path of raising interest rates by the Fed, becoming a path of decreasing interest rates with increasing balance sheet. On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues. DJIA increased 0.5 percent on Sep 11, decreasing 1.7 percent in the week. Germany’s DAX changed 0.0 percent on Sep 11 and increased 2.8 percent in the week. Dow Global increased 0.2 percent on Sep 11 and decreased 0.4 percent in the week. Japan’s Nikkei Average increased 0.7 percent on Sep 11 and increased 0.9 percent in the week of Sep 4, as the yen continues oscillating and the stock market gains in expectations of success of fiscal stimulus by a new administration and monetary stimulus by a new board of the Bank of Japan. Shanghai Composite that decreased 1.0 percent on Mar 8 and decreased 1.7 percent in the week of Mar 8, falling below 2000 at 1974.38 on Mar 12, 2014 but closing at 3260.35 on Sep 11, 2020 for increase of 0.8 percent and decreasing 2.8 percent in the week. The Shanghai Composite increased 65.1 percent from March 12, 2014 to Sep 11, 2020. There is deceleration with oscillations of the world economy that could affect corporate revenue and equity valuations, causing fluctuations in equity markets with increases during favorable risk appetite. The global hunt for yield induced by central bank policy rates of near zero percent motivates wide portfolio reshufflings among classes of risk financial assets.

Commodities were mixed in the week of Sep 11, 2020. Table III-1 shows that WTI decreased 6.1 percent in the week of Sep 11 while Brent decreased 6.6 percent in the week with turmoil in oil producing regions but oscillating action by OPEC now in negotiations with Russia. Gold decreased 0.8 percent on Sep 11 and increased 0.7 percent in the week of Sep 11.

Table III-I, Weekly Financial Risk Aug 7 to Sep 11, 2020

Fri 04	Mon 7	Tue 08	Wed 09	Thu 10	Fri 11
USD/EUR 1.1841 0.6% 0.1%	1.1816 0.2% 0.2%	1.1775 0.6% 0.3%	1.1804 0.3% -0.2%	1.1816 0.2% -0.1%	1.1848 -0.1% -0.3%
JPY/ USD 106.24 -0.8% 0.0%	106.28 0.0% 0.0%	106.04 0.2% 0.2%	106.18 0.1% -0.1%	106.13 0.1% 0.0%	106.16 0.1% 0.0%
CHF/ USD 0.9135 -1.0% -0.5%	0.9162 -0.3% -0.3%	0.9179 -0.5% -0.2%	0.9124 0.1% 0.6%	0.9106 0.3% 0.2%	0.9090 0.5% 0.2%
CHF/EUR 1.0814 -0.4% -0.3%	1.0829 -0.1% -0.1%	1.0804 0.1% 0.2%	1.0770 0.4% 0.3%	1.0761 0.5% 0.1%	1.0768 0.4% -0.1%
USD/ AUD 0.7283 1.3731 -1.1% 0.1%	0.7276 1.3744 -0.1% -0.1%	0.7213 1.3864 -1.0% -0.9%	0.7282 1.3732 0.0% 1.0%	0.7258 1.3778 -0.3% -0.3%	0.7283 1.3731 0.0% 0.3%
10Y Note 0.722	0.721	0.682	0.701	0.685	0.672
2Y Note 0.161	0.149	0.145	0.141	0.141	0.133
German Bond 2Y -0.70 10Y-0.47	2Y -0.70 10Y -0.46	2Y -0.70 10Y -0.49	2Y -0.69 10Y -0.46	2Y -0.66 10Y -0.43	2Y -0.69 10Y-0.48
DJIA 28133.31 -1.8% -0.6%	28133.31 0.0% 0.0%	27500.89 -2.2% -2.2%	27940.47 -0.7% 1.6%	27534.58 -2.1% -1.5%	27665.64 -1.7% 0.5%
Dow Global 3055.14 -1.8% -0.6%	3068.13 0.4% 0.4%	3021.18 -1.1% -1.5%	3056.61 0.0% 1.2%	3036.46 -0.6% -0.7%	3042.08 -0.4% 0.2%
DJ Asia Pacific NA	NA	NA	NA	NA	NA
Nikkei 23205.43 1.4% -1.1%	23089.95 -0.5% -0.5%	23274.13 0.3% 0.8%	23032.54 -0.7% -1.0%	23235.47 0.1% 0.9%	23406.49 0.9% 0.7%
Shanghai 3355.37 -1.4% -0.9%	3292.59 -1.9% -1.9%	3316.42 -1.2% 0.7%	3254.63 -3.0% -1.9%	3234.82 -3.6% -0.6%	3260.35 -2.8% 0.8%
DAX 12842.66 -1.5% -1.6%	13100.28 2.0% 2.0%	12968.33 1.0% -1.0%	13237.21 3.1% 2.1%	13208.89 2.9% -0.2%	13202.84 2.8% 0.0%
BOVESPA 101241.73 -0.9% 0.5%	101241.73 0.0% 0.0%	100050.43 -1.2% -1.2%	101292.05 0.0% 1.2%	98834.59 -2.4% -2.4%	98363.22 -2.8% -0.5%
DJ UBS Comm. NA	NA	NA	NA	NA	NA
WTI $/B 39.77 -7.4% -3.9%	39.77 0.0% 0.0%	36.76 -7.6% -7.6%	38.05 -4.3% 3.5%	37.30 -6.2% -2.0%	37.33 -6.1% 0.1%
Brent $/B 42.66 -6.9% -3.2%	42.01 -1.5% -1.5%	39.78 -6.8% -5.3%	40.79 -4.4% 2.5%	40.06 -6.1% -1.8%	39.83 -6.6% -0.6%
Gold 1934.3 -2.1% -0.2%	1934.3 0.0% 0.0%	1943.2 0.5% 0.5%	1954.9 1.1% 0.6%	1964.3 1.6% 0.5%	1947.9 0.7% -0.8%

Note: USD: US dollar; JPY: Japanese Yen; CHF: Swiss

Franc; AUD: Australian dollar; Comm.: commodities; OZ: ounce

Sources: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

https://www.investing.com/rates-bonds/world-government-bonds

The carry trade from zero interest rates to leveraged positions in risk financial assets had proved strongest for commodity exposures but US equities have regained leadership. On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues. The DJIA has increased 185.6 percent since the trough of the sovereign debt crisis in Europe on Jul 16, 2010 to Sep 11, 2020; S&P 500 has gained 226.7 percent and DAX 132.8 percent. Before the current round of risk aversion, almost all assets in the column “∆% Trough to 09/11/20” in Table VI-4 had double digit gains relative to the trough around Jul 2, 2010 followed by negative performance but now some valuations of equity indexes show varying behavior. China’s Shanghai Composite is 36.8 percent above the trough.  Japan’s Nikkei Average is 165.3 percent above the trough. Dow Global is 78.6 percent above the trough. STOXX 50 of 50 blue-chip European equities (https://www.stoxx.com/index-details?symbol=sx5E) is 30.0 percent above the trough. NYSE Financial Index is 65.1 percent above the trough. DAX index of German equities (http://www.bloomberg.com/quote/DAX:IND) is 132.8 percent above the trough. Japan’s Nikkei Average is 165.3 percent above the trough on Aug 31, 2010 and 105.4 percent above the peak on Apr 5, 2010. The Nikkei Average closed at 23,406.49 on Aug 11, 2020 (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata), which is 128.3 percent higher than 10,254.43 on Mar 11, 2011, on the date of the Tōhoku or Great East Japan Earthquake/tsunami. Global risk aversion erased the earlier gains of the Nikkei. The dollar appreciated 0.6 percent relative to the euro. The dollar devalued before the new bout of sovereign risk issues in Europe. The column “∆% week to 09/11/20” in Table VI-4 shows decrease of 2.8 percent for China’s Shanghai Composite. The Nikkei increased 0.9 percent. NYSE Financial decreased 2.3 percent in the week. Dow Global decreased 0.5 percent in the week of Sep 11, 2020. The DJIA decreased 1.7 percent and S&P 500 decreased 2.5 percent. DAX of Germany increased 2.8 percent. STOXX 50 increased 2.0 percent. The USD depreciated 0.1 percent. There are still high uncertainties on European sovereign risks and banking soundness, US and world growth slowdown and China’s growth tradeoffs. Sovereign problems in the “periphery” of Europe and fears of slower growth in Asia and the US cause risk aversion with trading caution instead of more aggressive risk exposures. There is a fundamental change in Table VI-4 from the relatively upward trend with oscillations since the sovereign risk event of Apr-Jul 2010. Performance is best assessed in the column “∆% Peak to 09/11/20” that provides the percentage change from the peak in Apr 2010 before the sovereign risk event to Sep 11, 2020. Most risk financial assets had gained not only relative to the trough as shown in column “∆% Trough to 09/11/20” but also relative to the peak in column “∆% Peak to 09/11/20.” There are now several equity indexes above the peak in Table VI-4: DJIA 146.9 percent, S&P 500 174.5 percent, DAX 108.5 percent, Dow Global 45.7 percent, NYSE Financial Index (https://www.nyse.com/quote/index/NYK.ID) 31.5 percent and Nikkei Average 105.4 percent. STOXX 50 is 10.1 percent above the peak. Shanghai Composite is 3.0 percent above the peak. The Shanghai Composite increased 65.1 percent from March 12, 2014, to Sep 11, 2020. The US dollar strengthened 21.7 percent relative to the peak. The factors of risk aversion have adversely affected the performance of risk financial assets. The performance relative to the peak in Apr 2010 is more important than the performance relative to the trough around early Jul 2010 because improvement could signal that conditions have returned to normal levels before European sovereign doubts in Apr 2010.

Table VI-4, Stock Indexes, Commodities, Dollar and Ten-Year Treasury  

	Peak	Trough	∆% to Trough	∆% Peak to 09/11/ /20	∆% Week 09/11/20	∆% Trough to 09/11/ 20
DJIA	4/26/ 10	7/2/10	-13.6	146.9	-1.7	185.6
S&P 500	4/23/ 10	7/20/ 10	-16.0	174.5	-2.5	226.7
NYSE Finance	4/15/ 10	7/2/10	-20.3	31.5	-2.3	65.1
Dow Global	4/15/ 10	7/2/10	-18.4	45.7	-0.5	78.6
Asia Pacific	4/15/ 10	7/2/10	-12.5	NA	NA	NA
Japan Nikkei Aver.	4/05/ 10	8/31/ 10	-22.5	105.4	0.9	165.3
China Shang.	4/15/ 10	7/02 /10	-24.7	3.0	-2.8	36.8
STOXX 50	4/15/10	7/2/10	-15.3	10.1	2.0	30.0
DAX	4/26/ 10	5/25/ 10	-10.5	108.5	2.8	132.8
Dollar Euro	11/25 2009	6/7 2010	21.2	21.7	-0.1	0.6
DJ UBS Comm.	1/6/ 10	7/2/10	-14.5	NA	NA	NA
10-Year T Note	4/5/ 10	4/6/10	3.986	2.784	2.658	0.672

T: trough; Dollar: positive sign appreciation relative to euro (less dollars paid per euro), negative sign depreciation relative to euro (more dollars paid per euro)

Source: http://professional.wsj.com/mdc/page/marketsdata.html?mod=WSJ_hps_marketdata

Bernanke (2010WP) and Yellen (2011AS) reveal the emphasis of monetary policy on the impact of the rise of stock market valuations in stimulating consumption by wealth effects on household confidence. Table VI-5 shows a gain by Apr 29, 2011 in the DJIA of 14.3 percent and of the S&P 500 of 12.5 percent since Apr 26, 2010, around the time when sovereign risk issues in Europe began to be acknowledged in financial risk asset valuations. The last row of Table VI-5 for Sep 11, 2020 shows that the S&P 500 is now 175.6 percent above the Apr 26, 2010 level and the DJIA is 146.9 percent above the level on Apr 26, 2010. Multiple rounds of risk aversion eroded earlier gains, showing that risk aversion can destroy market value even with zero interest rates. Relaxed risk aversion has contributed to recovery of valuations. Much the same as zero interest rates and quantitative easing have not had any effects in recovering economic activity while distorting financial markets and resources.

Table VI-5, Percentage Changes of DJIA and S&P 500 in Selected Dates

	∆% DJIA from prior date	∆% DJIA from Apr 26 2010	∆% S&P 500 from prior date	∆% S&P 500 from Apr 26 2010
Apr 26, 2010
May 06/10	-6.1	-6.1	-6.9	-6.9
May 26/10	-5.2	-10.9	-5.4	-11.9
Jun 08/10	-1.2	-11.3	2.1	-12.4
Aug 07, 2020	3.8	144.8	2.5	176.5
Aug 14, 2020	1.8	149.3	0.6	178.3
Aug 21, 2020	0.0	149.3	0.7	180.3
Aug 28, 2020	2.6	155.7	3.3	189.4
Sep 04, 2020	-1.8	151.1	-2.3	182.7
Sep 11, 2020	-1.7	146.9	-2.5	175.6

Source:

http://professional.wsj.com/mdc/public/page/mdc_us_stocks.html?mod=mdc_topnav_2_3014

http://professional.wsj.com/mdc/public/page/mdc_currencies.html?mod=mdc_topnav_2_3000

 

Table VI-7, updated with every blog comment, provides in the second column the yield at the close of market of the 10-year Treasury note on the date in the first column. The price in the third column is calculated with the coupon of 2.625 percent of the 10-year note current at the time of the second round of quantitative easing after Nov 3, 2010 and the final column “∆% 11/04/10” calculates the percentage change of the price on the date relative to that of 101.2573 at the close of market on Nov 4, 2010, one day after the decision on quantitative easing by the Fed on Nov 3, 2010. Prices with new coupons such as 2.0 percent in recent auctions (http://www.treasurydirect.gov/RI/OFAuctions?form=extended&cusip=912828RR3) are not comparable to prices in Table VI-7. The highest yield in the decade was 5.510 percent on May 1, 2001 that would result in a loss of principal of 22.9 percent relative to the price on Nov 4. Monetary policy has created a “duration trap” of bond prices. Duration is the percentage change in bond price resulting from a percentage change in yield or what economists call the yield elasticity of bond price. Duration is higher the lower the bond coupon and yield, all other things constant. This means that the price loss in a yield rise from low coupons and yields is much higher than with high coupons and yields. Intuitively, the higher coupon payments offset part of the price loss. Prices/yields of Treasury securities were affected by the combination of Fed purchases for its program of quantitative easing and by the flight to dollar-denominated assets because of geopolitical risks in the Middle East, subsequently by the tragic Great East Japan Earthquake and Tsunami and now again by the sovereign risk doubts in Europe and the growth recession in the US and the world. The yield of 0.672 percent at the close of market on Fri Sep 11, 2020 would be equivalent to price of 118.8576 in a hypothetical bond maturing in 10 years with coupon of 2.625 percent for price increase of 17.4 percent relative to the price on Nov 4, 2010, one day after the decision on the second program of quantitative easing, as shown in the last row of Table VI-7. The price loss between Sep 7, 2012 and Sep 14, 2012 would have been 1.7 percent in just five trading days. The price loss between Jun 1, 2012 and Jun 8, 2012 would have been 1.6 percent, in just a week, and much higher with leverage of 10:1 as typical in Treasury positions. The price loss between Mar 9, 2012 and Mar 16, 2012 is 2.3 percent but much higher when using common leverage of 10:1. The price loss between Dec 28, 2012 and Jan 4, 2013 would have been 1.7 percent. These losses defy annualizing. If inflation accelerates, yields of Treasury securities may rise sharply. Yields are not observed without special yield-lowering effects such as the flight into dollars caused by the events in the Middle East, continuing purchases of Treasury securities by the Fed, the tragic Tōhoku or Great East Earthquake and Tsunami of Mar 11, 2011 affecting Japan, recurring fears on European sovereign credit issues and worldwide risk aversion in the week of Sep 30 caused by “let’s twist again” monetary policy. There is a difficult climb from the record federal deficit of 9.8 percent of GDP in 2009 and cumulative deficit of $5090 billion in four consecutive years of deficits exceeding one trillion dollars from 2009 to 2012, which is the worst fiscal performance since World War II (https://cmpassocregulationblog.blogspot.com/2018/10/global-contraction-of-valuations-of.html and earlier https://cmpassocregulationblog.blogspot.com/2017/04/mediocre-cyclical-economic-growth-with.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/twenty-four-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/unresolved-us-balance-of-payments.html and earlier http://cmpassocregulationblog.blogspot.com/2016/04/proceeding-cautiously-in-reducing.html and earlier http://cmpassocregulationblog.blogspot.com/2015/09/monetary-policy-designed-on-measurable.html and earlier http://cmpassocregulationblog.blogspot.com/2015/06/fluctuating-financial-asset-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/12/patience-on-interest-rate-increases.html and earlier http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html and earlier Section IB at http://cmpassocregulationblog.blogspot.com/2012/08/expanding-bank-cash-and-deposits-with.html). There is no subsequent jump of debt in US peacetime history as the one from 39.4 percent of GDP in 2008 to 65.8 percent of GDP in 2011, 70.3 percent in 2012, 72.2 percent in 2013, 73.7 percent in 2014, 72.5 percent in 2015, 76.4 percent in 2016, 76.1 percent in 2017 and 77.8 percent in 2018 (https://www.cbo.gov/about/products/budget-economic-data#6) (https://cmpassocregulationblog.blogspot.com/2018/10/global-contraction-of-valuations-of.html and earlier  https://cmpassocregulationblog.blogspot.com/2017/04/mediocre-cyclical-economic-growth-with.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/twenty-four-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/07/unresolved-us-balance-of-payments.html and earlier http://cmpassocregulationblog.blogspot.com/2016/04/proceeding-cautiously-in-reducing.html and earlier (http://cmpassocregulationblog.blogspot.com/2016/01/weakening-equities-and-dollar.html and earlier http://cmpassocregulationblog.blogspot.com/2015/06/fluctuating-financial-asset-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/12/patience-on-interest-rate-increases.html and earlier http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html

 and earlier http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html and earlier http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). The US is facing an unsustainable debt/GDP path (https://cmpassocregulationblog.blogspot.com/2018/10/global-contraction-of-valuations-of.html and earlier and earlier http://cmpassocregulationblog.blogspot.com/2017/01/twenty-four-million-unemployed-or.html and earlier http://cmpassocregulationblog.blogspot.com/2016/12/rising-yields-and-dollar-revaluation.html http://cmpassocregulationblog.blogspot.com/2016/07/unresolved-us-balance-of-payments.html and earlier http://cmpassocregulationblog.blogspot.com/2016/01/weakening-equities-and-dollar.html and earlier http://cmpassocregulationblog.blogspot.com/2015/09/monetary-policy-designed-on-measurable.html and earlier http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/12/patience-on-interest-rate-increases.html and earlier http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier http://cmpassocregulationblog.blogspot.com/2014/08/monetary-policy-world-inflation-waves.html and earlier http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html and earlier http://cmpassocregulationblog.blogspot.com/2013/09/duration-dumping-and-peaking-valuations.html and earlier at http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html).

The Chair of the Federal Reserve Board, Jerome H. Powell, at the 61^st Annual Meeting on the National Association for Business Economics, on Oct 28, 2019, in Denver, Colorado, stated (https://www.federalreserve.gov/newsevents/speech/powell20191008a.htm): “Reserve balances are one among several items on the liability side of the Federal Reserve's balance sheet, and demand for these liabilities—notably, currency in circulation—grows over time. Hence, increasing the supply of reserves or even maintaining a given level over time requires us to increase the size of our balance sheet. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves.¹⁸ That time is now upon us.

I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis. Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy, to which I now turn.” On October 25, 2017, at the beginning of the FOMC programmed reduction of the balance sheet, Total Assets of Federal Reserve Banks stood at $4,461,117 million. Total Assets increased $2,549,497 million from $4,461,117 on Oct 25, 2017 to $7,010,614 on Sep 9, 2020. Total Assets of Federal Reserve Banks increased from $3,981,420 million on Feb 20, 2019 to $7,010,614 million on Sep 9, 2020, by $3,029,194 million or 76.1 percent. The policy of reducing the fed funds policy rate requires increasing the balance sheet. The line “Securities Held Outright” increased from $4,019,823 million on Oct 25, 2017 to $6,345,567 on Sep 9, 2020 or $2,325,744 million. Securities Held Outright increased from $3,617,939 million on Jul 1, 2019 to $6,345,567 on Sep 9, 2020 by $2,727,628 million or 75.4 percent. The portfolio of long-term securities (“securities held outright”) for monetary policy consists primarily of $5981 billion, or $5.98 trillion, of which $3,748 billion Treasury nominal notes and bonds, $281 billion of notes and bonds inflation-indexed, $2 billion Federal agency debt securities and $1950 billion mortgage-backed securities ($1,949,599 million). Reserve balances deposited with Federal Reserve Banks reached $2907 billion ($2,906,853 million) or $2.9 trillion (https://www.federalreserve.gov/releases/h41/current/h41.htm#h41tab1). The rounded values of $1649 billion of reserves deposited at Federal Reserve Banks and mortgage-backed securities are identical on Dec 19, 2018, by pure coincidence. There is no simple exit of this trap created by the highest monetary policy accommodation in US history together with the highest deficits and debt in percent of GDP since World War II. Risk aversion from various sources, discussed in section III World Financial Turbulence, has been affecting financial markets for several months. The risk is that in a reversal of exposures because of increasing risk aversion that has been typical in this cyclical expansion of the economy yields of Treasury securities may back up sharply.

Table VI-7, Yield, Price and Percentage Change to November 4, 2010 of Ten-Year Treasury Note

Date	Yield	Price	∆% 11/04/10
05/01/01	5.510	78.0582	-22.9
06/10/03	3.112	95.8452	-5.3
06/12/07	5.297	79.4747	-21.5
07/31/20	0.540	120.2704	18.8
08/07/20	0.567	119.9799	18.5
08/14/20	0.708	118.4756	17.0
08/21/20	0.633	119.2731	17.8
08/28/20	0.733	118.2111	16.7
09/04/20	0.722	118.3274	16.9
09/11/20	0.672	118.8576	17.4

Note: price is calculated for an artificial 10-year note paying semi-annual coupon and maturing in ten years using the actual yields traded on the dates and the coupon of 2.625% on 11/04/10

Source:

http://professional.wsj.com/mdc/public/page/mdc_bonds.html?mod=mdc_topnav_2_3000

 

Chart VI-8 of the Board of Governors of the Federal Reserve System provides the yield of the ten-year constant maturity Treasury and the overnight fed funds rate from Jan 2, 1962 to Sep 10, 2020. The yield of the ten-year constant maturity Treasury stood at 7.67 percent on Feb 16, 1977. A peak was reached at 15.21 percent on Oct 26, 1981 during the inflation control effort by the Fed. There is a second local peak in Chart VI-8 on May 3, 1984 at 13.94 percent followed by another local peak at 8.14 percent on Nov 21, 1994 during another inflation control effort (see Appendix I The Great Inflation). There was sharp reduction of the yields from 5.44 percent on Apr 1, 2002 until they reached a low point of 3.13 percent on Jun 13, 2003. The fed funds rate was 1.18 percent on Jun 23, 2003 and the ten-year yield 3.36 percent. Yields rose again to 4.89 percent on Jun 14, 2004 with the fed funds rate at 1.02 percent and the ten-year yield stood at 5.23 percent on Jul 5, 2006. At the onset of the financial crisis on Sep 17, 2007, the fed funds rate was 5.33 percent and the ten-year yield 4.48 percent. On Dec 26, 2008, the fed funds rate was 0.09 percent and the ten-year yield 2.16 percent. Yields declined sharply during the financial crisis, reaching 2.08 percent on Dec 18, 2008, lowered by higher prices originating in sharply increasing demand in the flight to the US dollar and obligations of the US government. Yields rose again to 4.01 percent on Apr 5, 2010 but collapsed to 2.41 percent on Oct 8, 2010 because of higher demand originating in the flight from the European sovereign risk event. During higher risk appetite, yields rose to 3.75 percent on Feb 8, 2011 and reached 0.68 percent on Sep 10, 2020 with the fed funds rate at 0.09 percent. Chart VI-8A provides the fed funds rate and the yield of the ten-year constant maturity Treasury from Jan 2, 2001 to Sep 10, 2020. The final data point for Sep 10, 2020, shows the fed funds rate at 0.09 percent and the yield of the ten-year constant maturity Treasury at 0.68 percent. There has been a trend of decline of yields with oscillations. During periods of risk aversion investors seek protection in obligations of the US government, causing decline in their yields. In an eventual resolution of international financial risks with higher economic growth, there could be the trauma of rising yields with significant capital losses in portfolios of government securities. The data in Table VI-7 in the text is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

Chart VI-8, US, Overnight Federal Funds Rate and Ten-Year Treasury Constant Maturity Yield, Jan 2, 1962 to Sep 10, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Chart VI-8A provides the fed funds rate and the yield of the ten-year constant maturity Treasury from Jan 2, 2001 to Sep 10, 2020. The final data point for Sep 10, 2020, shows the fed funds rate at 0.09 percent and the yield of the ten-year constant maturity Treasury at 0.68 percent. There has been a trend of decline of yields with oscillations. During periods of risk aversion investors seek protection in obligations of the US government, causing decline in their yields. In an eventual resolution of international financial risks with higher economic growth, there could be the trauma of rising yields with significant capital losses in portfolios of government securities. The data in Table VI-7 in the text is obtained from closing dates in New York published by the Wall Street Journal (http://professional.wsj.com/mdc/public/page/marketsdata.html?mod=WSJ_PRO_hps_marketdata).

 

Chart VI-8A, US, Overnight Federal Funds Rate and Ten-Year Treasury Constant Maturity Yield, Jan 2, 2001 to Sep 10, 2020

Note: US Recessions in Shaded Areas

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Chart VI-9 of the Board of Governors of the Federal Reserve System provides securities held outright by Federal Reserve banks from 2002 to 2020. The first data point in Chart VI-9 is the level for Dec 18, 2002 of $629,407 million and the final data point in Chart VI-9 is level of $6,345,567 million on Sep 9, 2020. On October 25, 2017, at the beginning of the FOMC programmed reduction of the balance sheet, Total Assets of Federal Reserve Banks stood at $4,461,117 million. Total Assets increased $2,549,497 million from $4,461,117 on Oct 25, 2017 to $7,010,614 on Sep 9, 2020. Total Assets of Federal Reserve Banks increased from $3,981,420 million on Feb 20, 2019 to $7,010,614 million on Sep 9, 2020 by $3,029,194 million or 76.1 percent. The policy of reducing the fed funds policy rate requires increasing the balance sheet. The line “Securities Held Outright” increased from $4,019,823 million on Oct 25, 2017 to $6,345,567 on Sep 9, 2020 or $2,325,744 million. Securities Held Outright increased from $3,617,939 million on Jul 24, 2019 to $6,345,567 on Sep 9, 2020 by $2,727,628 million or 75.4 percent. The Chair of the Federal Reserve Board, Jerome H. Powell, at the 61^st Annual Meeting on the National Association for Business Economics, on Oct 28, 2019, in Denver, Colorado, stated (https://www.federalreserve.gov/newsevents/speech/powell20191008a.htm): “Reserve balances are one among several items on the liability side of the Federal Reserve's balance sheet, and demand for these liabilities—notably, currency in circulation—grows over time. Hence, increasing the supply of reserves or even maintaining a given level over time requires us to increase the size of our balance sheet. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves.¹⁸ That time is now upon us.

I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis. Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy, to which I now turn.”

Chart VI-9, US, Securities Held Outright by Federal Reserve Banks, Wednesday Level, Dec 18, 2002 to Sep 9, 2020, USD Millions

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/monetarypolicy/bst_fedsbalancesheet.htm

Chart VI-9A of the Board of Governors of the Federal Reserve System provides Total Assets by Federal Reserve banks from 2002 to 2020 (https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H41). The first data point in Chart VI-9A is the level for Dec 18, 2002 of $720,761 million and the final data point in Chart VI-9A is level of $7,010,614 million on Sep 9, 2020.  On October 25, 2017, at the beginning of the FOMC programmed reduction of the balance sheet, Total Assets of Federal Reserve Banks stood at $4,461,117 million. Total Assets increased $2,549,497 million from $4,461,117 on Oct 25, 2017 to $7,010,614 on Sep 9, 2020. Total Assets of Federal Reserve Banks increased from $3,981,420 million on Feb 20, 2019 to $7,010,614 million on Sep 9, 2020, by $3,029,194 million or 76.1 percent. The policy of reducing the fed funds policy rate requires increasing the balance sheet. The Chair of the Federal Reserve Board, Jerome H. Powell, at the 61^st Annual Meeting on the National Association for Business Economics, on Oct 28, 2019, in Denver, Colorado, stated (https://www.federalreserve.gov/newsevents/speech/powell20191008a.htm): “Reserve balances are one among several items on the liability side of the Federal Reserve's balance sheet, and demand for these liabilities—notably, currency in circulation—grows over time. Hence, increasing the supply of reserves or even maintaining a given level over time requires us to increase the size of our balance sheet. As we indicated in our March statement on balance sheet normalization, at some point, we will begin increasing our securities holdings to maintain an appropriate level of reserves.¹⁸ That time is now upon us.

I want to emphasize that growth of our balance sheet for reserve management purposes should in no way be confused with the large-scale asset purchase programs that we deployed after the financial crisis. Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy, to which I now turn.”

Chart VI-9A, US, Total Assets by Federal Reserve Banks, Wednesday Level, Dec 18, 2002 to Sep 9, USD Millions

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/monetarypolicy/bst_fedsbalancesheet.htm

Chart VI-10 of the Board of Governors of the Federal Reserve System provides the overnight Fed funds rate on business days from Jul 1, 1954 at 1.13 percent through Jan 10, 1979, at 9.91 percent per year, to Sep 10, 2020, at 0.09 percent per year. US recessions are in shaded areas according to the reference dates of the NBER (http://www.nber.org/cycles.html). In the Fed effort to control the “Great Inflation” of the 1970s (http://cmpassocregulationblog.blogspot.com/2011/05/slowing-growth-global-inflation-great.html https://cmpassocregulationblog.blogspot.com/2011/04/new-economics-of-rose-garden-turned.html https://cmpassocregulationblog.blogspot.com/2011/03/is-there-second-act-of-us-great.html and Appendix I The Great Inflation; see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB and  http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html), the fed funds rate increased from 8.34 percent on Jan 3, 1979 to a high in Chart VI-10 of 22.36 percent per year on Jul 22, 1981 with collateral adverse effects in the form of impaired savings and loans associations in the United States, emerging market debt and money-center banks (see Pelaez and Pelaez, Regulation of Banks and Finance (2009b), 72-7; Pelaez 1986, 1987). Another episode in Chart VI-10 is the increase in the fed funds rate from 3.15 percent on Jan 3, 1994, to 6.56 percent on Dec 21, 1994, which also had collateral effects in impairing emerging market debt in Mexico and Argentina and bank balance sheets in a world bust of fixed income markets during pursuit by central banks of non-existing inflation (Pelaez and Pelaez, International Financial Architecture (2005), 113-5). Another interesting policy impulse is the reduction of the fed funds rate from 7.03 percent on Jul 3, 2000, to 1.00 percent on Jun 22, 2004, in pursuit of equally non-existing deflation (Pelaez and Pelaez, International Financial Architecture (2005), 18-28, The Global Recession Risk (2007), 83-85), followed by increments of 25 basis points from Jun 2004 to Jun 2006, raising the fed funds rate to 5.25 percent on Jul 3, 2006 in Chart VI-10. Central bank commitment to maintain the fed funds rate at 1.00 percent induced adjustable-rate mortgages (ARMS) linked to the fed funds rate. Lowering the interest rate near the zero bound in 2003-2004 caused the illusion of permanent increases in wealth or net worth in the balance sheets of borrowers and also of lending institutions, securitized banking and every financial institution and investor in the world. The discipline of calculating risks and returns was seriously impaired. The objective of monetary policy was to encourage borrowing, consumption and investment but the exaggerated stimulus resulted in a financial crisis of major proportions as the securitization that had worked for a long period was shocked with policy-induced excessive risk, imprudent credit, high leverage and low liquidity by the incentive to finance everything overnight at interest rates close to zero, from adjustable rate mortgages (ARMS) to asset-backed commercial paper of structured investment vehicles (SIV).

The consequences of inflating liquidity and net worth of borrowers were a global hunt for yields to protect own investments and money under management from the zero interest rates and unattractive long-term yields of Treasuries and other securities. Monetary policy distorted the calculations of risks and returns by households, business and government by providing central bank cheap money. Short-term zero interest rates encourage financing of everything with short-dated funds, explaining the SIVs created off-balance sheet to issue short-term commercial paper with the objective of purchasing default-prone mortgages that were financed in overnight or short-dated sale and repurchase agreements (Pelaez and Pelaez, Financial Regulation after the Global Recession, 50-1, Regulation of Banks and Finance, 59-60, Globalization and the State Vol. I, 89-92, Globalization and the State Vol. II, 198-9, Government Intervention in Globalization, 62-3, International Financial Architecture, 144-9). ARMS were created to lower monthly mortgage payments by benefitting from lower short-dated reference rates. Financial institutions economized in liquidity that was penalized with near zero interest rates. There was no perception of risk because the monetary authority guaranteed a minimum or floor price of all assets by maintaining low interest rates forever or equivalent to writing an illusory put option on wealth. Subprime mortgages were part of the put on wealth by an illusory put on house prices. The housing subsidy of $221 billion per year created the impression of ever-increasing house prices. The suspension of auctions of 30-year Treasuries was designed to increase demand for mortgage-backed securities, lowering their yield, which was equivalent to lowering the costs of housing finance and refinancing. Fannie and Freddie purchased or guaranteed $1.6 trillion of nonprime mortgages and worked with leverage of 75:1 under Congress-provided charters and lax oversight. The combination of these policies resulted in high risks because of the put option on wealth by near zero interest rates, excessive leverage because of cheap rates, low liquidity because of the penalty in the form of low interest rates and unsound credit decisions because the put option on wealth by monetary policy created the illusion that nothing could ever go wrong, causing the credit/dollar crisis and global recession (Pelaez and Pelaez, Financial Regulation after the Global Recession, 157-66, Regulation of Banks, and Finance, 217-27, International Financial Architecture, 15-18, The Global Recession Risk, 221-5, Globalization and the State Vol. II, 197-213, Government Intervention in Globalization, 182-4). A final episode in Chart VI-10 is the reduction of the fed funds rate from 5.41 percent on Aug 9, 2007, to 2.97 percent on October 7, 2008, to 0.12 percent on Dec 5, 2008 and close to zero throughout a long period with the final point at 0.09 percent on Sep 10, 2020. Evidently, this behavior of policy would not have occurred had there been theory, measurements and forecasts to avoid these violent oscillations that are clearly detrimental to economic growth and prosperity without inflation. The Chair of the Board of Governors of the Federal Reserve System, Janet L. Yellen, stated on Jul 10, 2015 that (http://www.federalreserve.gov/newsevents/speech/yellen20150710a.htm):

 

“Based on my outlook, I expect that it will be appropriate at some point later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy. But I want to emphasize that the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step. I currently anticipate that the appropriate pace of normalization will be gradual, and that monetary policy will need to be highly supportive of economic activity for quite some time. The projections of most of my FOMC colleagues indicate that they have similar expectations for the likely path of the federal funds rate. But, again, both the course of the economy and inflation are uncertain. If progress toward our employment and inflation goals is more rapid than expected, it may be appropriate to remove monetary policy accommodation more quickly. However, if progress toward our goals is slower than anticipated, then the Committee may move more slowly in normalizing policy.”

 

There is essentially the same view in the Testimony of Chair Yellen in delivering the Semiannual Monetary Policy Report to the Congress on Jul 15, 2015 (http://www.federalreserve.gov/newsevents/testimony/yellen20150715a.htm). The FOMC (Federal Open Market Committee) raised the fed funds rate to ¼ to ½ percent at its meeting on Dec 16, 2015 (http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm).

It is a forecast mandate because of the lags in effect of monetary policy impulses on income and prices (Romer and Romer 2004). The intention is to reduce unemployment close to the “natural rate” (Friedman 1968, Phelps 1968) of around 5 percent and inflation at or below 2.0 percent. If forecasts were reasonably accurate, there would not be policy errors. A commonly analyzed risk of zero interest rates is the occurrence of unintended inflation that could precipitate an increase in interest rates similar to the Himalayan rise of the fed funds rate from 9.91 percent on Jan 10, 1979, at the beginning in Chart VI-10, to 22.36 percent on Jul 22, 1981. There is a less commonly analyzed risk of the development of a risk premium on Treasury securities because of the unsustainable Treasury deficit/debt of the United States (https://cmpassocregulationblog.blogspot.com/2018/10/global-contraction-of-valuations-of.html and earlier  https://cmpassocregulationblog.blogspot.com/2017/04/mediocre-cyclical-economic-growth-with.html and earlier http://cmpassocregulationblog.blogspot.com/2017/01/twenty-four-million-unemployed-or.html and earlier and earlier http://cmpassocregulationblog.blogspot.com/2016/12/rising-yields-and-dollar-revaluation.html http://cmpassocregulationblog.blogspot.com/2016/07/unresolved-us-balance-of-payments.html and earlier http://cmpassocregulationblog.blogspot.com/2016/04/proceeding-cautiously-in-reducing.html and earlier http://cmpassocregulationblog.blogspot.com/2016/01/weakening-equities-and-dollar.html and earlier http://cmpassocregulationblog.blogspot.com/2015/09/monetary-policy-designed-on-measurable.html and earlier http://cmpassocregulationblog.blogspot.com/2015/06/fluctuating-financial-asset-valuations.html and earlier (http://cmpassocregulationblog.blogspot.com/2015/03/irrational-exuberance-mediocre-cyclical.html and earlier http://cmpassocregulationblog.blogspot.com/2014/12/patience-on-interest-rate-increases.html

 and earlier http://cmpassocregulationblog.blogspot.com/2014/09/world-inflation-waves-squeeze-of.html and earlier (http://cmpassocregulationblog.blogspot.com/2014/02/theory-and-reality-of-cyclical-slow.html and earlier (http://cmpassocregulationblog.blogspot.com/2013/02/united-states-unsustainable-fiscal.html). There is not a fiscal cliff or debt limit issue ahead but rather free fall into a fiscal abyss. The combination of the fiscal abyss with zero interest rates could trigger the risk premium on Treasury debt or Himalayan hike in interest rates.

Chart VI-10, US, Fed Funds Rate, Business Days, Jul 1, 1954 to Sep 10, 2020, Percent per Year

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Chart VI-11 of the Board of Governors of the Federal Reserve System provides the fed funds rate and the prime bank loan rate in business days from Aug 4, 1955 to Sep 10, 2020. The overnight fed funds rate was 2.0 percent on Aug 4, 1955 and the bank prime rate 3.25 percent. The fed funds overnight rate is the rate charged by a depository institution with idle reserves deposited at a federal reserve bank to exchange its deposits overnight to another depository institution in need of reserves. In a sense, it is the marginal cost of funding for a bank in the United States, or the cost of a unit of additional funding. The fed funds rate is the rate charged by a bank to another bank in an uncollateralized overnight loan. The fed funds rate is the traditional policy rate or rate used to implement policy directives of the Federal Open Market Committee (FOMC). Thus, there should be an association between the fed funds rate or cost of funding of a bank and its prime lending rate. Such an association is verified in Chart VI-11 with the rates moving quite closely over time. On January 10, 1979, the fed funds rate was set at 9.91 percent and banks set their prime lending rate at 11.75 percent. On Dec 16, 2008, the policy determining committee of the Fed decided (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm): “The Federal Open Market Committee decided today to establish a target range for the federal funds rate of 0 to ¼  percent.” On Dec 14, 2016 (https://www.federalreserve.gov/newsevents/press/monetary/20161214a.htm), “the Committee decided to raise the target level for the federal funds rate to ½ to ¾ percent.” On Mar 15, 2017, “the Committee decided to raise the federal funds rate to ¾ to 1 percent (https://www.federalreserve.gov/newsevents/pressreleases/monetary20170315a.htm). The FOMC raised the fed funds rate to 1 to 1 ¼ percent at its meeting on Jun 14, 2017 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20170201a.htm). The FOMC increased the fed funds rate to 1¼ to 1½ percent on Dec 13, 2017 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20171213a.htm). The FOMC increased the fed funds rate to 1½ to 1¾ percent on Mar 21, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180321a.htm). The FOMC increased the fed funds rate to 1¾ to 2.0 percent on Jun 13, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180613a.htm). The FOMC increased the fed funds rate to 2.0 to 2¼ percent on Sep 26, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180926a.htm). The FOMC increased the fed funds rate to 2¼ to 2½ percent on Dec 19, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20181219a.htm). The FOMC decreased the fed funds rate to 2 to 2¼ percent on Jul 31, 2019 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm). The FOMC decreased the fed funds rate to 1¾ to 2.0 percent on Sep 18, 2019 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190918a.htm).

The FOMC decreased the fed funds rate to 1½ to 1¾ percent on Oct 30, 2019 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20191030a.htm). The FOMC decreased the fed funds rate to 1 to 1¼ percent on Mar 3, 2020 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200303a.htm). The FOMC decreased the fed funds rate to 0 to ¼ percent on Mar 15, 2020 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315a.htm). On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues.

The final segment of Chart VI-11 shows similar movement of the fed funds rate and the prime bank loan rate following the fixing of the fed funds rate to approximately zero. In the final data point of Chart VI-11 on Sep 10, 2020, the fed funds rate is 0.09 percent and the prime rate 3.25 percent. The causes of the financial crisis and global recession were interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero-interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash. The yields of Treasury securities inverted on Mar 22, 2019 with the ten-year yield at 2.44 percent below those of 2.49 percent for one-month, 2.48 percent for two months, 2.46 percent for three months, 2.48 percent for six months and 2.45 percent for one year (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). The final segment after 2001 shows the effects of unconventional monetary policy of extremely low, below inflation fed funds rate in lowering yields. This was an important cause of the global recession and financial crisis inducing as analyzed by Taylor (2018Oct 19, 2) “search for yield, excessive risk taking, a boom and bust in the housing market, and eventually the financial crisis and recession.” Monetary policy deviated from the Taylor Rule (Taylor 2018Oct19 see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2019Oct19 and  http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html)). An explanation is in the research of Adrian, Estrella and Shin (2018, 21-22): “Our findings suggest that the monetary tightening of 2004-2006 period ultimately did achieve a slowdown in real activity not because of its impact on the level of longer term interest rates, but rather because of its impact on the slope of the yield curve. In fact, while the level of the 10-year yield only increased 38 basis points between June 2004 and 2006, the term spread declined 325 basis points (from 3.44 to .19 percent). The fact that the slope flattened meant that intermediary profitability was compressed, thus shifting the supply of credit, and hence inducing changes in real activity. The 18 month lag between the end of the tightening cycle, and the beginning of the recession is perfectly compatible with effective monetary tightening.” See (https://www.newyorkfed.org/research/capital_markets/ycfaq.html). A major difference in the current cycle is the balance sheet of the Fed with purchases used to lower interest rates in specific segments and maturities such as mortgage-backed securities and longer terms.

Chart VI-11, US, Fed Funds Rate and Prime Bank Loan, Aug 4, 1955 to Sep 10, 2020, Percent per Year

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Lending has become more complex over time. The critical fact of current world financial markets is the combination of “unconventional” monetary policy with intermittent shocks of financial risk aversion. There are two interrelated unconventional monetary policies. First, unconventional monetary policy consists of (1) reducing short-term policy interest rates toward the “zero bound” such as fixing the fed funds rate at 0 to ¼ percent by decision of the Federal Open Market Committee (FOMC) since Dec 16, 2008 (http://www.federalreserve.gov/newsevents/press/monetary/20081216b.htm). Second, unconventional monetary policy also includes a battery of measures to also reduce long-term interest rates of government securities and asset-backed securities such as mortgage-backed securities. When inflation is low, the central bank lowers interest rates to stimulate aggregate demand in the economy, which consists of consumption and investment. When inflation is subdued and unemployment high, monetary policy would lower interest rates to stimulate aggregate demand, reducing unemployment. When interest rates decline to zero, unconventional monetary policy would consist of policies such as large-scale purchases of long-term securities to lower their yields. A major portion of credit in the economy is financed with long-term asset-backed securities. Loans for purchasing houses, automobiles and other consumer products are bundled in securities that in turn are sold to investors. Corporations borrow funds for investment by issuing corporate bonds. Loans to small businesses are also financed by bundling them in long-term bonds. Securities markets bridge the needs of higher returns by investors obtaining funds from savers that are channeled to consumers and business for consumption and investment. Lowering the yields of these long-term bonds could lower costs of financing purchases of consumer durables and investment by business. The essential mechanism of transmission from lower interest rates to increases in aggregate demand is portfolio rebalancing. Withdrawal of bonds in a specific maturity segment or directly in a bond category such as currently mortgage-backed securities causes reductions in yield that are equivalent to increases in the prices of the bonds. There can be secondary increases in purchases of those bonds in private portfolios in pursuit of their increasing prices. Lower yields translate into lower costs of buying homes and consumer durables such as automobiles and also lower costs of investment for business.

Monetary policy can lower short-term interest rates quite effectively. Lowering long-term yields is somewhat more difficult. The critical issue is that monetary policy cannot ensure that increasing credit at low interest cost increases consumption and investment. There is a large variety of possible allocation of funds at low interest rates from consumption and investment to multiple risk financial assets. Monetary policy does not control how investors will allocate asset categories. A critical financial practice is to borrow at low short-term interest rates to invest in high-risk, leveraged financial assets. Investors may increase in their portfolios asset categories such as equities, emerging market equities, high-yield bonds, currencies, commodity futures and options and multiple other risk financial assets including structured products. If there is risk appetite, the carry trade from zero interest rates to risk financial assets will consist of short positions at short-term interest rates (or borrowing) and short dollar assets with simultaneous long positions in high-risk, leveraged financial assets such as equities, commodities and high-yield bonds. Low interest rates may induce increases in valuations of risk financial assets that may fluctuate in accordance with perceptions of risk aversion by investors and the public. During periods of muted risk aversion, carry trades from zero interest rates to exposures in risk financial assets cause temporary waves of inflation that may foster instead of preventing financial instability (Section I and earlier https://cmpassocregulationblog.blogspot.com/2017/06/fomc-interest-rate-increase-planned.html and earlier https://cmpassocregulationblog.blogspot.com/2017/05/dollar-devaluation-world-inflation.html). During periods of risk aversion such as fears of disruption of world financial markets and the global economy resulting from collapse of the European Monetary Union, carry trades are unwound with sharp deterioration of valuations of risk financial assets. More technical  discussion is in IA Appendix: Transmission of Unconventional Monetary Policy at http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html.

Chart VI-12 of the Board of Governors of the Federal Reserve System provides the fed funds rate, prime bank loan rate and the yield of a corporate bond rated Baa by Moody’s. On Jan 10, 1979, the fed funds rate was fixed at 9.91 percent and banks fixed the prime loan rate at 11.75 percent. Reflecting differences in risk, the fed funds rate was 8.76 percent on Jan 2, 1986, the prime rate 9.50 percent and the Baa Corporate bond yield 11.38 percent. The yield of the Baa corporate bond collapsed toward the bank prime loan rate after the end of extreme risk aversion in the beginning of 2009. The final data point in Chart VI-12 is for Jul 7, 2016, with the fed funds rate at 0.40 percent, the bank prime rate at 3.50 percent and the yield of the Baa corporate bond at 4.19 percent. Empirical tests of the transmission of unconventional monetary policy to actual increases in consumption and investment or aggregate demand find major hurdles (see IA Appendix: Transmission of Unconventional Monetary Policy at http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html).

http://cmpassocregulationblog.blogspot.com/2012/11/united-states-unsustainable-fiscal.html).

Chart VI-12, US, Fed Funds Rate, Prim Bank Loan Rate and Yield of Moody’s Baa Corporate Bond, Business Days, Aug 4, 1955 to Jul 7, 2016, Percent per Year

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Chart VI-12A of the Board of Governors of the Federal Reserve System provides the overnight fed funds rate and the bank prime rate on business days from Jan 5, 2007 to Sep 10, 2020. There is a jump in the rates and yield with the increase in fed funds rates target range from 0 to ½ percent to ¼ to ½ percent on Dec 16, 2015 by the Federal Open Market Committee (http://www.federalreserve.gov/newsevents/press/monetary/20151216a.htm), ½ to ¾ percent on Dec 14, 2016 (https://www.federalreserve.gov/newsevents/press/monetary/20161214a.htm) and ¾ to 1 percent on Mar 15, 2017 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20170315a.htm). The FOMC raised the fed funds rate to 1 to 1¼ percent at its meeting on Jun 14, 2017 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20170201a.htm). The FOMC increased the fed funds rate to 1¼ to 1½ percent on Dec 13, 2017 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20171213a.htm). The FOMC increased the fed funds rate to 1½ to 1¾ percent on Mar 21, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180321a.htm). The FOMC increased the fed funds rate to 1¾ to 2.0 percent on Jun 13, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180613a.htm). The FOMC increased the fed funds rate to 2.0 to 2¼ percent on Sep 26, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20180926a.htm). The FOMC increased the fed funds rate to 2¼ to 2½ percent on Dec 19, 2018 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20181219a.htm).  The FOMC decreased the fed funds rate to 2 to 2¼ on Jul 31, 2019 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190731a.htm). The FOMC decreased the fed funds rate to 1¾ to 2.0 percent on Sep 18, 2019 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20190918a.htm). The FOMC decreased the fed funds rate to 1½ to 1¾ on Oct 30, 2019 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20191030a.htm). The FOMC decreased the fed funds rate to 1 to 1¼ percent on Mar 3, 2020 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200303a.htm). The FOMC decreased the fed funds rate to 0 to ¼ percent on Mar 15, 2020 (https://www.federalreserve.gov/newsevents/pressreleases/monetary20200315a.htm). On Aug 27, 2020, the Federal Open Market Committee changed its Longer-Run Goals and Monetary Policy Strategy, including the following (https://www.federalreserve.gov/monetarypolicy/review-of-monetary-policy-strategy-tools-and-communications-statement-on-longer-run-goals-monetary-policy-strategy.htm): “The Committee judges that longer-term inflation expectations that are well anchored at 2 percent foster price stability and moderate long-term interest rates and enhance the Committee's ability to promote maximum employment in the face of significant economic disturbances. In order to anchor longer-term inflation expectations at this level, the Committee seeks to achieve inflation that averages 2 percent over time, and therefore judges that, following periods when inflation has been running persistently below 2 percent, appropriate monetary policy will likely aim to achieve inflation moderately above 2 percent for some time.” The new policy can affect relative exchange rates depending on relative inflation rates and country risk issues. The final segment of Chart VI-11 shows similar movement of the fed funds rate and the prime bank loan rate following the fixing of the fed funds rate to approximately zero. In the final data point of Chart VI-12A on Sep 10, 2020, the fed funds rate is 0.09 percent and the prime rate 3.25 percent.  The causes of the financial crisis and global recession were interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero-interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash. The yields of Treasury securities inverted on Mar 22, 2019 with the ten-year yield at 2.44 percent below those of 2.49 percent for one-month, 2.48 percent for two months, 2.46 percent for three months, 2.48 percent for six months and 2.45 percent for one year (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). Unconventional monetary policy of extremely low interest rates was an important cause of the global recession and financial crisis inducing as analyzed by Taylor (2018Oct 19, 2) “search for yield, excessive risk taking, a boom and bust in the housing market, and eventually the financial crisis and recession.” Monetary policy deviated from the Taylor Rule (Taylor 2018Oct19 see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2019Oct19 and  http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html)). An explanation is in the research of Adrian, Estrella and Shin (2018, 21-22): “Our findings suggest that the monetary tightening of 2004-2006 period ultimately did achieve a slowdown in real activity not because of its impact on the level of longer term interest rates, but rather because of its impact on the slope of the yield curve. In fact, while the level of the 10-year yield only increased 38 basis points between June 2004 and 2006, the term spread declined 325 basis points (from 3.44 to .19 percent). The fact that the slope flattened meant that intermediary profitability was compressed, thus shifting the supply of credit, and hence inducing changes in real activity. The 18 month lag between the end of the tightening cycle, and the beginning of the recession is perfectly compatible with effective monetary tightening.” See (https://www.newyorkfed.org/research/capital_markets/ycfaq.html). A major difference in the current cycle is the balance sheet of the Fed with purchases used to lower interest rates in specific segments and maturities such as mortgage-backed securities and longer terms.

Chart VI-12A, US, Fed Funds Rate and Prime Bank Loan Rate, Business Days, Jan 5, 2007 to Sep 10, 2020, Percent per Year

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

Chart VI-12B of the Board of Governors of the Federal Reserve System provides the fed funds rate and prime bank loan rate on business days from Jan 2, 2001 to Sep 10, 2020. The behavior over time is that of controlled interest rates. Unconventional monetary policy with zero interest rates and quantitative easing is quite difficult to unwind because of the adverse effects of raising interest rates on valuations of risk financial assets and home prices, including the very own valuation of the securities held outright in the Fed balance sheet. Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero-interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash. The final segment shows the repetition of this policy with minute increases in interest rates. The causes of the financial crisis and global recession were interest rate and housing subsidies and affordability policies that encouraged high leverage and risks, low liquidity and unsound credit (Pelaez and Pelaez, Financial Regulation after the Global Recession (2009a), 157-66, Regulation of Banks and Finance (2009b), 217-27, International Financial Architecture (2005), 15-18, The Global Recession Risk (2007), 221-5, Globalization and the State Vol. II (2008b), 197-213, Government Intervention in Globalization (2008c), 182-4). Several past comments of this blog elaborate on these arguments, among which: http://cmpassocregulationblog.blogspot.com/2011/07/causes-of-2007-creditdollar-crisis.html http://cmpassocregulationblog.blogspot.com/2011/01/professor-mckinnons-bubble-economy.html http://cmpassocregulationblog.blogspot.com/2011/01/world-inflation-quantitative-easing.html http://cmpassocregulationblog.blogspot.com/2011/01/treasury-yields-valuation-of-risk.html http://cmpassocregulationblog.blogspot.com/2010/11/quantitative-easing-theory-evidence-and.html http://cmpassocregulationblog.blogspot.com/2010/12/is-fed-printing-money-what-are.html Gradual unwinding of 1 percent fed funds rates from Jun 2003 to Jun 2004 by seventeen consecutive increases of 25 percentage points from Jun 2004 to Jun 2006 to reach 5.25 percent caused default of subprime mortgages and adjustable-rate mortgages linked to the overnight fed funds rate. The zero-interest rate has penalized liquidity and increased risks by inducing carry trades from zero interest rates to speculative positions in risk financial assets. There is no exit from zero interest rates without provoking another financial crash. The yields of Treasury securities inverted on Mar 22, 2019 with the ten-year yield at 2.44 percent below those of 2.49 percent for one-month, 2.48 percent for two months, 2.46 percent for three months, 2.48 percent for six months and 2.45 percent for one year (https://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield). The final segment after 2001 shows the effects of unconventional monetary policy of extremely low, below inflation fed funds rate in lowering yields. This was an important cause of the global recession and financial crisis inducing as analyzed by Taylor (2018Oct 19, 2) “search for yield, excessive risk taking, a boom and bust in the housing market, and eventually the financial crisis and recession.” Monetary policy deviated from the Taylor Rule (Taylor 2018Oct19 see Taylor 1993, 1997, 1998LB, 1999, 2012FP, 2012Mar27, 2012Mar28, 2012JMCB, 2019Oct19 and  http://cmpassocregulationblog.blogspot.com/2017/01/rules-versus-discretionary-authorities.html http://cmpassocregulationblog.blogspot.com/2012/06/rules-versus-discretionary-authorities.html)). An explanation is in the research of Adrian, Estrella and Shin (2018, 21-22): “Our findings suggest that the monetary tightening of 2004-2006 period ultimately did achieve a slowdown in real activity not because of its impact on the level of longer term interest rates, but rather because of its impact on the slope of the yield curve. In fact, while the level of the 10-year yield only increased 38 basis points between June 2004 and 2006, the term spread declined 325 basis points (from 3.44 to .19 percent). The fact that the slope flattened meant that intermediary profitability was compressed, thus shifting the supply of credit, and hence inducing changes in real activity. The 18 month lag between the end of the tightening cycle, and the beginning of the recession is perfectly compatible with effective monetary tightening.” See (https://www.newyorkfed.org/research/capital_markets/ycfaq.html). A major difference in the current cycle is the balance sheet of the Fed with purchases used to lower interest rates in specific segments and maturities such as mortgage-backed securities and longer terms.

Chart VI-12B, US, Fed Funds Rate and Prime Bank Loan Rate, Business Days, Jan 2, 2001 to Sep 10, 2020, Percent per Year

Source: Board of Governors of the Federal Reserve System

https://www.federalreserve.gov/datadownload/Choose.aspx?rel=H15

 

© Carlos M. Pelaez, 2009, 2010, 2011, 2012, 2013, 2014, 2015, 2016, 2017, 2018, 2019, 2020.