j-underhill-blog

[j-underhill-blog]

Wells Fargo's high-pressure sales culture starts at the top

After reports of fraud, identity theft and forgery, Wells Fargo has promised to clean up its act. But based on recent statements by the CEO, the bank’s troubles are just beginning.

Over the span of five years, Wells Fargo fired 5,300 employees for opening as many as 2 million fake accounts. Roughly 85,000 of those accounts incurred $2 million in fees.

In many cases, customers were unaware of the accounts and the accompanying fees. Those accounts became delinquent, and customers were forced to fight with debt collectors over the fraudulent charges. Their credit reports were damaged, which affects everything from job applications to mortgages.

Wells Fargo’s bad apples

Wells Fargo describes the problem as the actions of just a few low level employees– not a systemic issue, and not something that represents company culture. The CFO, John Shrewsberry, explained,

These bad practices were not a revenue-generating activity. It was really more at the lower end of the performance scale, where people apparently were making bad choices to hang on to their job.

The CEO, John Stumpf, agreed, telling The Wall Street Journal, “The 1% that did it wrong, who we fired, terminated, in no way reflects our culture,” and that “[t]here was no incentive to do bad things.”

So why did 5,000 people do bad things with “no incentive”?

Eight rhymes with great

According to a complaint filed last year, employees were often required to work unpaid overtime to meet unreachable goals:

Wells Fargo has strict quotas regulating the number of daily “solutions” that its bankers must reach; these “solutions” include the opening of all new banking and credit card accounts. Managers constantly hound, berate, demean and threaten employees to meet these unreachable quotas.

Bankers weren’t expected to just open one account for a customer. They had to open multiple accounts, known as cross-selling. If a customer has a checking account, a banker would be expected to sell them a mortgage, sell them wealth-management products, or credit card accounts. Management set a goal of eight products per customer. Every single person who walked into a Wells Fargo branch needed to have eight accounts.

Why eight? Stumpf addressed this question in the company’s 2010 annual report:

I’m often asked why we set a cross-sell goal of eight. The answer is, it rhymed with “great.” Perhaps our new cheer should be: “Let’s go again, for ten!”

That’s a goal not based on branch traffic or an analysis of customer demand, but based on wordplay.

A rock and a hard place

Over the past five years, there were numerous signs that Wells Fargo’s strict sales quotas created problems, from customer complaints to labor lawsuits. These suits alleged the company forced employees to work beyond their typical schedule without pay– in some cases to meet sales goals. Top reviews on Glassdoor.com warned of the perverse incentives, while dozens of Youtube videos spoofed the bank’s aggressive sales environment.

One employee, Bill Bado, decided to alert the company’s ethics department of the problems in 2013. Shortly after, he was fired, according to a report by CNN Money.

CEO John Stumpf recently admitted to being aware of the problems in 2013, when the LA Times published a scathing piece, which described a micro-managed, high-pressure sales culture:

One former branch manager… discover[ed] that employees had talked a homeless woman into opening six checking and savings accounts with fees totaling $39 a month.

“I’m not aware of any overbearing sales culture,” Chief Financial Officer Timothy Sloan said in an interview.

Despite the denials, Wells Fargo held multi-day ethics seminars in 2014 to try to stop employees from making fake accounts. But, according to The Wall Street Journal, the message didn’t quite get through to one manager, who after the meeting “urged her employees to ignore the bosses and get sales up at any cost.”

The practices continued because the impossible quotas weren’t changed.

Denial at the top

Wells Fargo did announce that it plans to eliminate the aggressive sales goals by next year. But as far as recognizing the pressures placed on employees, that fell short.

When Oregon Senator Jeff Merkley asked if Wells Fargo created a pressure-cooker sales culture that put bankers in an difficult situation, CEO John Stumpf responded, “I do not believe that.”

While Stumpf has repeatedly said that he holds himself accountable, he continues to deny that he instilled a high-pressure environment that fostered the problems.

Change needs to be driven by recognition and true accountability at the top. Until that happens, it’s going to be business as usual.

[j-underhill-blog]

Fed holds rates, paves the way for a December hike

The Federal Reserve once again pushed back plans to raise interest rates on Wednesday, a widely expected move following a series of mixed economic reports and varied signals from Fed officials.

After its two-day policy meeting, the Federal Open Market Committee voted to hold the federal funds rate between 0.25% and 0.50%, citing progress in economic and labor market growth and an improving risk outlook.

“The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives,” the central bank wrote in its statement.

It’s worth noting, however, that three members of the committee — Kansas City Fed President Esther George, Cleveland Fed President Loretta Mester and Boston Fed President Eric Rosengren — voted against the decision, preferring to raise the federal funds rate to 0.50% to 0.75% at this meeting.

“The highly-unusual 7-3 FOMC vote speaks to the complexity facing the Fed operating in a prolonged period of highly unbalanced policy mix,” Allianz’s Mohamed El-Erian said.

For the first time this year, the Fed noted that “near-term risks to the economic outlook appear roughly balanced.” The reintroduction of the balance of risks statement, a sentence the Fed included in nearly all of its 2015 press releases, is a step some analysts consider a necessary precursor to a rate increase.

The Fed’s cautious, yet generally positive, economic statement follows a slew of mixed data in August, including weak retail sales, soft ISM manufacturing and services readings, and slower-than-expected hiring. The unemployment rate has hovered around 5% for the past year—a level many economists consider to be near full employment. However, output growth has been less than impressive. Real GDP is now estimated to have increased only 1.1% in the second quarter.

“[G]rowth of economic activity has picked up from the modest pace seen in the first half of the year,” the Fed wrote in its statement. “Although the unemployment rate is little changed in recent months, job gains have been solid on average.”

Meanwhile, inflation, which has run below the Fed’s 2% target for years, has started to show signs of improvement. The personal consumption expenditures index, the Fed’s preferred measure of price inflation, increased 0.8% in July from the year before, as core inflation rose 1.6%. Another measure of inflation, the core reading of the Consumer Price Index, rose 2.3% year-over-year in August. However, the Fed sees inflation remaining “low in the near term.”

Fed projections and dot plots

The Fed’s expectations for short-term and long-term GDP growth dropped to 1.8% from 2%, while forecasts for unemployment remained mostly unchanged, with officials expecting the rate to fall to 4.6% by 2019. The outlook for core inflation decreased to 1.8% by 2017.

Fed officials’ projections for the federal funds rate dropped, indicating one quarter-point increase this year, rather than the two hikes envisioned in June. Shortly after the Fed began raising rates last year—for the first time in over a decade—turmoil in US markets and uncertainty abroad convinced many officials to delay further rate increases.

Long run expectations for the fed funds rate also declined to 2.9% from the 3.0% forecasted in June.

Below is full text of the Fed’s announcement:

Information received since the Federal Open Market Committee met in July indicates that the labor market has continued to strengthen and growth of economic activity has picked up from the modest pace seen in the first half of this year. Although the unemployment rate is little changed in recent months, job gains have been solid, on average. Household spending has been growing strongly but business fixed investment has remained soft. Inflation has continued to run below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation remain low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to remain low in the near term, in part because of earlier declines in energy prices, but to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.

Against this backdrop, the Committee decided to maintain the target range for the federal funds rate at 1/4 to 1/2 percent. The Committee judges that the case for an increase in the federal funds rate has strengthened but decided, for the time being, to wait for further evidence of continued progress toward its objectives. The stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to 2 percent inflation.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.

The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; James Bullard; Stanley Fischer; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action were: Esther L. George, Loretta J. Mester, and Eric Rosengren, each of whom preferred at this meeting to raise the target range for the federal funds rate to 1/2 to 3/4 percent.

[j-underhill-blog]

Why the Fed could stun the world on Wednesday

It’s the billion dollar question: Will Federal Reserve officials raise rates or won’t they?

While expectations are very low that the Fed will announce an interest rate hike after its policy meeting on Wednesday, there are some contrarians who believe the Fed could still surprise the markets.

“[C]ommunications from many FOMC members indicate a willingness to prepare markets for the next rate increase, if not move to that rate increase directly,” write Michael Gapen, Rob Martin, and Blerina Uruçi of Barclays Research. “Against this backdrop, we retain our outlook for a rate hike in September. We believe the data have met the Fed’s threshold.”

However, Gapen, Martin, and Uruçi do hedge their bets, noting that the decision is a close call given lackluster inflation data and Fed officials’ potential “unwillingness to buck market pricing,” which could mean foregoing action at the September meeting in favor of sending a strong signal for a hike before year-end.

A slew of mixed data in August, including weak retail sales, soft ISM manufacturing and services readings, and slower-than-expected hiring, lowered market expectations for a September rate hike to 15%, after spiking as high as 42% following Fed chair Janet Yellen’s Jackson Hole speech last month.

The unemployment rate has hovered around 5% for the past year– a level many economists consider to be near full employment. However, the Fed’s preferred measure of inflation, core PCE, remains at 1.6%, below the Fed’s target of 2%.

“In our view, the inflation data have evolved generally in line with the Fed’s forecasts, pass-through effects are clearly fading, most committee members retain a ‘reasonable confidence’ standard for inflation returning to the 2% target, and members are increasingly worried about financial instability,” explain Gapen, Martin, and Uruçi. “Persistent credibility issues, in our view, mean the committee will likely have to ignore market pricing no matter when it moves. Hence, we doubt the situation will become much clearer in December.”

Another measure of inflation, core CPI, rose 2.3% year-over-year in August. This is evidence that the Fed is making progress with its inflation mandate, notes Chris Rupkey, chief financial economist at MUFJ.

“The Fed’s got the wrong darn inflation indicator on their dashboard. No wonder they can’t drive interest rates higher,” said Rupkey. “Let’s see what Yellen does now– whether she confounds market expectations and takes the advice of 8 out of 12 reserve bank presidents and moves rates up ‘cautiously and gradually’ by 25 bps at the September meeting… Stay tuned. The Fed decision is going down to the wire.”

With the economy near full employment and signs of increasing wages, inflation risks are rising, notes Torsten Slok, chief international economist at Deutsche Bank. “In that case, the Fed will no longer have the luxury of being slow, gradual, and cautious, and this continues to be a significant risk to the ongoing hunt for yield in the markets,” he says.

[j-underhill-blog]

Where the Fed stands on a September rate hike

Is September going to be the month the Federal Reserve raises rates for the first time this year?

Don’t hold your breath. Given the mixed economic data and the lack of a clear signal from Fed speeches, many economists have low expectations the Fed will announce any policy changes after its meeting on Wednesday.

“Fed officials made no concerted effort to raise market expectations over the last two weeks, and the FOMC almost never surprises with a hike. As a result, we now see very low chances (<5%) of a rate increase next week,” said Zach Pandl and Jan Hatzius of Goldman Sachs Global Investment Research.

Meanwhile, market expectations for a September rate hike have dropped to 12%, after spiking as high as 42% following Fed chair Janet Yellen’s Jackson Hole speech last month.

A slew of mixed data in August, including weak retail sales, soft ISM manufacturing and services readings, and slower-than-expected hiring, lowered the outlook for a rate hike. However, consumer price inflation came in above expectations on Friday, making the Fed’s decision not so straightforward.

With the economy already at full employment and signs of increasing wages, inflation risks are rising, notes Torsten Slok, chief international economist at Deutsche Bank. “In that case, the Fed will no longer have the luxury of being slow, gradual, and cautious, and this continues to be a significant risk to the ongoing hunt for yield in the markets,” he said.

Also complicating matters: The Bank of Japan, which meets on Tuesday, and the Bank of England are considering dropping their interest rates further.

Here are the latest comments from Fed officials on the economy and the possibility of a rate hike (FOMC voting members are highlighted in green):

Lael Brainard, Fed Governor, on September 12th: “[T]he case to tighten policy preemptively is less compelling,” given that low unemployment has failed to increase inflation.

Neel Kashkari, Minneapolis Fed, on September 12th:  “There doesn’t appear to be a huge urgency to do anything.”

Dennis Lockhart, Atlanta Fed, on September 12th: “If 1.6 percent inflation and 4.9 percent unemployment were all you knew about the economy, would you consider a policy setting one tick above the zero lower bound still appropriate? …I think circumstances call for a lively discussion next week.” However, he later added that there was no urgency to act at any particular meeting.

Eric Rosengren, Boston Fed, on September 9th: “A reasonable case can be made for continuing to pursue a gradual normalization of monetary policy…a failure to continue on the path of gradual removal of accommodation could shorten the duration of this recovery.”

Robert Kaplan, Dallas Fed, on September 9th: The Fed can afford to be “patient and deliberate in its actions.”

Daniel Tarullo, Fed Governor, on September 9th: “I wouldn’t foreclose that possibility [of raising rates this year]… What is optimal right now is to look to see actual evidence that the inflation rate would continue to go up and would be sustained at around the target.”

Jeffrey Lacker, Richmond Fed, on September 7th: “It looks like the case for a rate increase is going to be strong in September.”

John Williams, San Francisco Fed, on September 6th: “[It] makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later.”

Loretta Mester, Cleveland Fed, on September 1: “If you have a forecast and inflation is moving up to your target and you’re at full employment, then it seems like a gradual increase from a very low interest rate is pretty compelling to me. Pre-emptiveness is important.”

Charles Evans, Chicago Fed, on August 31st: “If necessary, we could normalize policy much faster than currently envisioned and still keep the pace gradual enough to avoid a disorderly change in financial conditions.”

Stanley Fischer, Fed vice chair, on August 26:  Fischer noted that Yellen’s comments (earlier in the day) were consistent with a move in September and possibly two hikes this year.

Janet Yellen, Fed chair, on August 26: “I believe the case for an increase in the federal funds rate has strengthened in recent months.”

Jerome Powell, Fed Governor, on August 26: “We can afford to be patient…when we see progress toward 2% inflation and a tightening labor market, and growth strong enough to support all that, we should take the opportunity [to raise rates].”

James Bullard, St. Louis Fed, on August 26th: “I’m agnostic on exactly when we [raise rates].”

Esther George, Kansas City Fed, on August 25th: “When I look at where we are with the job market, when I look at inflation and our forecast for that, I think it’s time to move.”

William Dudley, New York Fed, on August 16th: “We’re edging closer towards the point in time where it’ll be appropriate to raise interest rates further.”

Patrick Harker, of the Philadelphia Fed, has been quiet about his stance on a rate hike, but he did vote to increase the Fed’s discount rate in July.

[j-underhill-blog]

Why shredding $100 bills could be good for the economy: Rogoff

While more than half of all transactions in the US are electronic—think debit cards, Apple Pay and Venmo—there’s still a record $1.4 trillion in physical currency, from $1 to $100 bills, circulating in the global economy.

That’s almost double the amount from a decade ago, and about 80% of that cash is in $100 bills.

These large bills could be making us poorer and less safe, says Kenneth Rogoff, Harvard economist and author of the new book “The Curse of Cash.” For Rogoff, the benefits of phasing out both $50 and $100 bills are two-fold: It would hamper criminal activity and aid monetary policy.

“I argue [large bills] are more facilitating activity in the underground economy—crime, tax evasion, you name it—than they are in legal activity,” Rogoff told Yahoo Finance.

But cash can also be used as a form of civil disobedience for what is perceived to be an unjust law or an onerous regulation. Where exactly do we draw the line between a government’s right to enforce laws and the public’s right to privacy?

He admits that phasing out cash is a highly politicized and emotional topic, adding that the economy will still need cash—at least the smaller bills— for reasons of natural disasters, privacy, and unbanked neighborhoods.

“It’s 22 pounds for $1 million in hundreds, but it’s 220 pounds to carry around $1 million in tens,” said Rogoff. “So I’m looking for… how can people still do $500, $1,000, sort of retail transactions, but not be able to run these criminal enterprises.”

A less-cash society and central banking

In addition to hampering the underground economy, phasing out larger bills could give central banks additional tools to fight recessions and deflation, says Rogoff.

After the 2008 financial crisis, the Federal Reserve dropped its benchmark interest rate to near zero, with the expectation that low rates would stimulate the economy. The Bank of Japan and the European Central Bank took their policies a step farther, lowering rates into negative territory. In Germany, for example, an investor pays for the right to loan the government money for 10 years.

But central banks’ ability to venture into negative territory is limited, as people have the ability to convert their investments into cash and get 0% interest. If a central bank decides to lower rates to -5%, at some point investors are just going to take cash, rather than get a negative return in a checking account. This scenario would be counterproductive to a central bank’s efforts to fight a recession and deflationary pressures.

“When we wake up and see that there are only $10 bills, it’s way easier to have serious negative interest rates,” said Rogoff. “The idea is not that you’d have negative 6% rates for 10 years, but it would last a relatively brief period because you’re powering the economy out of the recession.”

In principle, Rogoff notes, there is no reason that currency holders should prefer a world with 2% inflation and a 0% interest rate on currency to a world with 0% inflation and and a -2% interest rate on currency. In both cases, the real rate of return on currency is -2%.

But should we give the government the right to tax our currency?

“Well, let’s face it. They can do whatever they want now,” Rogoff said. “There’s inflation. That works really well. It’s been used time and again. You are trusting the central bank apparatus to be trying to stabilize output, trying to stabilize inflation. Yeah, they can set a negative tax rate—a negative rate on currency. But if the market’s not calling for that, the currency is just going to empty out.”

[j-underhill-blog]

Here’s where all the Fed officials stand on an interest rate hike

Speak now or hold your peace until September 22.

Today marks the last day of speeches from Federal Reserve officials before they gather to discuss monetary policy and a potential rate hike at the Sept. 20-21 Federal Open Market Committee (FOMC) meeting.

In the final speech before the quiet period begins, Fed Governor Lael Brainard assured the markets that she wasn’t in a hurry to raise rates.

Given that low unemployment has failed to increase inflation “the case to tighten policy preemptively is less compelling,” Brainard said.

“My main point here is that in the presence of uncertainty and the absence of accelerating inflationary pressures, it would be unwise for policy to foreclose on the possibility of making further gains in the labor market,” she added.

The speech, which was announced late last week, was highly anticipated as some expected that Brainard, a noted dove, might take on a hawkish tone to raise market expectations for tightening at the September meeting, but this was not the case.

“Asymmetry in risk management in today’s new normal counsels prudence in the removal of policy accommodation,” Brainard said, noting that the risk of being unable to respond to unexpected economic weakness is greater than the risk of inflation spiking due to strength in demand.

Brainard added that in the current environment the “federal funds rate is less accommodative today than it would have been 10 years ago.”

The unemployment rate has hovered around 5% for the past year, a level many economists consider to be near full employment. However, core PCE inflation remains at 1.6%, below the Fed’s 2% target.

Recent economic data has also been mixed, with the ISM manufacturing index contracting in August and the ISM services index slowing to the weakest pace in six years.

After Brainard’s speech, market expectations for a September rate hike dropped to 15% with the majority of traders forecasting a rate hike by the end of the year.

Brainard was one of three Fed speakers today and one of ten in the past two weeks. Here are the most recent comments from other Fed officials on the economy and interest rate path (FOMC voters are bolded):

Neel Kashkari on September 12th: “There doesn’t appear to be a huge urgency to do anything.”

Dennis Lockhart on September 12th: “If 1.6 percent inflation and 4.9 percent unemployment were all you knew about the economy, would you consider a policy setting one tick above the zero lower bound still appropriate? …I think circumstances call for a lively discussion next week.” However, he later added that there was no urgency to act at any particular meeting.

Eric Rosengren on September 9th: “A reasonable case can be made for continuing to pursue a gradual normalization of monetary policy…a failure to continue on the path of gradual removal of accommodation could shorten the duration of this recovery. “

Robert Kaplan on September 9th: The Fed can afford to be “patient and deliberate in its actions.”

Daniel Tarullo  on September 9th: “I wouldn’t foreclose that possibility [of raising rates this year]… What is optimal right now is to look to see actual evidence that the inflation rate would continue to go up and would be sustained at around the target.”

Jeffrey Lacker on September 7th: “It looks like the case for a rate increase is going to be strong in September.”

John Williams on September 6th: “[It] makes sense to get back to a pace of gradual rate increases, preferably sooner rather than later.”

Loretta Mester September 1: “If you have a forecast and inflation is moving up to your target and you’re at full employment, then it seems like a gradual increase from a very low interest rate is pretty compelling to me. Pre-emptiveness is important.”

Charles Evans on August 31st: “If necessary, we could normalize policy much faster than currently envisioned and still keep the pace gradual enough to avoid a disorderly change in financial conditions.”

Stanley Fischer on August 26:  Fischer noted that Yellen’s comments (earlier in the day) were consistent with a move in September and possibly two hikes this year.

Janet Yellen on August 26: “I believe the case for an increase in the federal funds rate has strengthened in recent months.”

Jerome Powell on August 26: “We can afford to be patient…when we see progress toward 2% inflation and a tightening labor market, and growth strong enough to support all that, we should take the opportunity [to raise rates].”

James Bullard on August 26th: “I’m agnostic on exactly when we [raise rates]”

Esther George on August 25th: “When I look at where we are with the job market, when I look at inflation and our forecast for that, I think it’s time to move.”

William Dudley on August 16th: “We’re edging closer towards the point in time where it’ll be appropriate to raise interest rates further.”

Patrick Harker has been quiet about his stance on a rate hike, but he did vote to increase the Fed’s discount rate in July.

[j-underhill-blog]

All the new clues Janet Yellen dropped about the next Fed rate hike

It’s the event investors have been waiting for all week: Federal Reserve Chair Janet Yellen’s speech at the Kansas City Fed’s Economic Policy Symposium, in Jackson Hole, Wyoming.

In her speech, Yellen presented an optimistic view of the economy, providing a few hints about the path of future rate hikes.

“Indeed, in light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months,” Yellen said, stressing that the economy is now nearing the Fed’s goals of maximum employment and price stability.

However, she did note that inflation remained weak, dampening the need to increase rates soon.

“[T]he FOMC expects moderate growth in real gross domestic product (GDP), additional strengthening in the labor market, and inflation rising to 2 percent over the next few years,” Yellen said.

While the speech, titled “The Federal Reserve’s Monetary Policy Toolkit,” focused mostly on how to battle the next crisis in a slow growth and low rate environment, she devoted the first section to discussing current economic trends.

“Based on this economic outlook, the FOMC continues to anticipate that gradual increases in the federal funds rate will be appropriate over time to achieve and sustain employment and inflation near our statutory objectives,” she said.

Given that the Fed is nearing its goals on employment and inflation, it is also nearing the time for another rate hike, notes Chris Rupkey, chief financial economist at The Bank of Tokyo Mitsubishi. “The Fed Chair would not have raised the curtain like this if she were not almost certain that September was the time to resume their gradual and cautious pace of rate hikes,” he said.

In recent weeks a few members of the Fed, including Fed Vice Chair Stanley Fischer, have echoed Yellen’s positive economic outlook.

“We are close to our targets,” Fischer said at The Aspen Institute in Colorado, citing strength in the labor market and improving inflation data.

The unemployment rate has hovered around 5% for the past year, a level many economists consider to be near full employment. But most importantly, said Fischer, it’s been resilient– it stayed low even as the dollar strengthened, during the turmoil in China and uncertainties of the Brexit.

“The August jobs report will help clarify the level of urgency felt among FOMC members to boost rates before the end of the year,” said Mark Hamrick, Bankrate’s senior economic analyst. “My sense is the odds remain against a September boost, but favor a move around December, as long as there’s no dramatic change in incoming economic data.”

Meanwhile, output growth has been less than impressive. Real GDP is now estimated to have increased only 1.1%, revised downward from an initial reading of 1.2%.

“U.S. economic activity continues to expand, led by solid growth in household spending…While economic growth has not been rapid, it has been sufficient to generate further improvement in the labor market,” said Yellen.

The next Federal Open Market Committee meeting is set for September 20-21. Market expectations for a September rate hike remain low at 24% with the majority of traders forecasting a rate hike by the end of the year.

[j-underhill-blog]

Stiglitz: The days of the euro are numbered

Nearly a decade after the financial crisis, the eurozone’s jobless rate still hovers around 10%, almost double that of the US.

But aggregates of the eurozone don’t tell the whole story. Austria’s unemployment sits below 6% while Spain’s has topped 20%. Between 2008-2014, Greek household disposable income fell by 24% while German households gained 15%, according to EU data.

The main culprit for the dichotomy is the shared currency, says Joseph Stiglitz, Nobel Prize-winning economist and author of the new book, The Euro: How a Common Currency Threatens the Future of Europe.

Yet, for Stiglitz, the problems were evident from the beginning. “[T]hose in Europe deliberating about adopting the euro should consider whether they should tie their fortunes to an institutional arrangement whose flaws are apparent,” wrote Stiglitz in 2003, as a handful of countries, including Cyprus, Slovenia and Estonia, sought to adopt the currency.

Now, a decade later, Europe’s great monetary endeavor has led to economic stagnation and severe inequality, he says.

“The euro is a man-made construction” writes Stiglitz. “Europe’s monetary arrangements can be reconfigured; the euro can be abandoned if necessary.”

While the reforms he proposes, including common deposit insurance, eurobonds and a move away from austerity policies, are relatively straightforward, the political climate needed to institute the change is not. The longer it takes to make reforms, the more fractured countries will become– a cycle which could eventually diminish political will to save the eurozone.

We sat down with Joseph Stiglitz to discuss critical missteps in the formation of the euro, currency reforms, and the EU’s path forward. Below is an edited section of our interview; the video interview is above.

———————–

YAHOO: It seems the crux of the issue is that monetary unity came before political unity. So why wasn’t that part of the equation when they first set out? 

JOSEPH STIGLITZ: Well, the creation of the single currency was a political project. It was driven by the desire to be the next step in bringing the countries of Europe together.

But the politics wasn’t strong enough, you might say, to finish the project. To make a successful single currency, you had to realize that you were taking away, too, the most important instruments for adjusting when you had an economic shock, like the recession of 2008. So you took away the interest rate. You took away the currency adjustment mechanism, but they didn’t put anything in the place.

And instead, they made things even worse. Because they tied the hands of the countries of Europe by saying you have to limit the deficits and the debt. And then they said to the central bank, focus just on inflation. Don’t pay any attention to employment, jobs, financial stability. They believed, somehow, that all this would work out, that politically it would work out, that eventually, they would create the necessary institutions.

Economically, they thought markets would make sure things would work out, because if you maintain deficits and debt low and low inflation, automatically you’d be brought to full employment and rapid growth. Well, it hasn’t worked out. And theory said it wouldn’t work out.

YAHOO: As economic stagnation continues, there’s a lot more anti-EU rhetoric and populism. Do you see there being a tipping point at which the euro or the EU can’t be saved? JOSEPH STIGLITZ: Very much so. And in fact, you almost see a beginning of that with Brexit. Now, remember, the UK was not in the eurozone. But when they looked across the English Channel at what was going on inside the eurozone, one of the things they saw was rigid bureaucrats. They saw a system that was not able to adapt to the differences in circumstances. It was imposing the same rules everywhere, rules that might make sense in Germany, but didn’t make sense in other countries. They saw a dysfunctional eurozone. And their trading partners in Europe were not doing very well. And so they said, do we want to be a member of that club?

Now, what’s going to happen, I think– and what is happening already– is that the parties in the center– the center-left, the center-right– that have been supporting the concept of the euro are losing support. You see that in poll after poll. And people are moving to the extreme parties. And that’s a danger.

Because eventually, unless they make the reforms that I describe in the book– unless they make the institutions that will make the euro actually work for most of the citizens– unless they do that, the discontent will grow. And eventually, there will be vote of a country within the euro that says– a party will get elected, one of the extreme parties, a coalition, that will say we’ve had it. And they will call for a referendum like the Brexit. And there’s a good chance– and I think it’s almost inevitable, eventually, unless the reforms occur– that there will be an exit. Whether it’s Italy or Spain or Greece, it’s hard to tell. But it’s hard to see it not happening.

YAHOO: Now, some of the reforms that you suggest include deposit insurance, euro bonds, and a move away from austerity policies. Do you see that possible now in this political climate in Europe? Is it almost like they’re in a catch-22, where they need to implement reforms but they can’t? 

JOSEPH STIGLITZ: These reforms are not big in an economic sense. But you’re absolutely right– it’s the politics. And while they’re not big in an economic sense, they’re too big for the politics of Europe as it’s constructed today.

You don’t know what will happen when, as you say, push comes to shove. They see the light. They see Brexit. They see this discontent. And they say, look, we have to actually do what we’re supposed to.

Unfortunately, some of the response to Brexit was suggesting that rather than doing that, they were going to move in the other direction, a hard line attitude. Juncker, who’s the head of the European Commission, said we are not going to give UK a good deal. We’re going to treat it harshly, because we want to make sure that other countries won’t leave.

When you think about that for a minute, what he was saying– this is the head of the European Commission– was saying the benefits to the citizens of Europe were so low that the only way to keep them supporting the euro was to threaten them with disaster if they leave. Now, that’s not the way to create a partnership.  YAHOO: You’ve suggested the idea of a northern and a southern euro. How exactly would that work?

JOSEPH STIGLITZ: Well, the first thing to realize is that the regional work on the design of currency area by my colleague at Columbia, Bob Mundell, emphasized that currency areas were better when there’s enough homogeneity. And there’s a closer similarity– not perfect, but closer similarity– among the countries of the south, not only in economics, but in political philosophy, and so too for the countries of north. So the prospects of two or three currency areas working are far greater than the prospect of a single currency working for the whole world.

If you ask the question could America join with a currency area of Latin America and the United States, we would say, oh no. When we talked about NAFTA, nobody said we need to have a single currency, because they knew it would not work. We could have a free trade area, but making a single currency work with countries as different as Mexico, Canada and the United States was not going to work.

In fact, even Canada and the United States have different currencies. We get along well. We have lots of economic relationship. It’s beneficial to both of us. But there’s not a single currency. So that’s the key idea.

Now, once you recognize that, there’s not a flood of money to the United States or to Canada. The money allocates itself on the basis of where the returns are highest. And the exchange rates are just to equilibrate the returns. So that’s the whole point.

If you have flexible exchange rates, you don’t get the rush of money going from one place to another, because you get the exchange rate to make the adjustment. So everybody says the returns are reasonably the same in the different parts.

YAHOO: But initially, once you institute that change suddenly, say tomorrow, we’re going to have a southern euro currency and a northern euro currency. Wouldn’t there be some sort of issue in implementing that overnight? 

JOSEPH STIGLITZ: Well, I try to address that in the book. And this is one of the more novel proposals in the book, where I try to take advantage of the advances of technology that have occurred. Those advances mean that that paper money that we all use has become a thing of the past. In fact, people don’t use paper very much. Most of the transactions are done electronically. 99.9% are done electronically in value terms.

So once you realize that, that means we could go to a fully digital currency. A lot of people have been saying we ought to do it. It has a lot of advantages in terms of record keeping, tax avoidance, monitoring people to make sure that there isn’t tax evasion– a lot of advantages. And if you did that, you would have the mechanism to circumscribe the kind of flight that you would worry about.

And so initially, you might have to put in those kinds of controls. Fairly quickly, things would equilibriate after that moment of panic. And this electronic currency has a further advantage– you don’t have to print all that money. You don’t need the printing presses. A lot of people in Greece were thinking about leaving. They say, who’s going to print the money, and how are you going to keep it secret?

Well, the point is, you can create this electronic platform. In fact, it’s almost there.

[j-underhill-blog]

Experts can't agree on what the Fed said in its July statement

The Federal Reserve’s July policy statement has been parsed, sliced and diced by analysts looking for any clues about the next rate hike, and one particular line buried in the second paragraph of the release caught Wall Street’s attention:

“Near-term risks to the economic outlook have diminished.”

For the first time this year the Fed acknowledged subsiding economic risks, a 180-degree pivot from the March statement when it warned of risks abroad.

The new language brings the Fed one step closer to reintroducing its balance of risks statement, a sentence the Fed included in nearly all of its 2015 press releases, which read “[the] Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced.”

When the Fed finally voted to raise rates in December — for the first time in over a decade — the statement described risks as “balanced.” Many Fed watchers agree that including balanced risks language will be a prerequisite for another rate increase.

However, it seems analysts agree on little else in the July statement. Some believe the statement opens the Fed to a September rate hike, while others expect a rate increase in December. Still others think the Fed will hold off until next year.

One thing is for sure: The Fed managed to leave its options open.

Here are some excerpts from analyst and economist notes:

Chris Rupkey, The Bank of Tokyo Mitsubishi: “Rate hikes are coming. Bet on it.”

“The July meeting is the setup for a potential rate hike in September, if the data continue to come in in a way that suggests the Fed is getting closer to achieving its goals …

If they go in September for the first time since last December you can’t be anymore gradual and cautious than that. Get on with it is our view. We think Yellen will raise the curtain on a September move at Jackson Hole in August. The economy is better than Fed officials think. Rate hikes are coming. Bet on it.”

BofA Merrill Lynch Global Research: “We expect the Fed to hike in December”

“The FOMC sounded more upbeat about the health of the labor market, noting that payrolls and other labor market indicators point to some increase in labor utilization …

We think the FOMC is preparing for another hike, but it is not imminent … We continue to believe that a September hike is unlikely, but expect conditions to be met by December to justify a rate hike, assuming no additional negative shocks.”

Omair Sharif, Societe Generale Group: Fed will wait “until next year to hike”

“Admittedly, this was a more confident statement than we expected from Fed officials …

In our view, the Fed is likely to reintroduce the balance of risks statement prior to the rate hike. So, one can envision a scenario where the Fed brings back that statement in the September communiqué in advance of a rate hike in December. A move to a ‘balanced’ assessment may be foreshadowed at Yellen’s Jackson Hole speech on August 26. While that scenario is plausible, we continue to expect the Fed to punt on a rate hike until 2017.”

Goldman Sachs Economic Research: “A roughly 70% probability of at least one rate increase this year”

“We think the statement keeps open the committee’s options for a rate increase later this year, possibly as soon as September. Accordingly, we modestly raised our subjective odds of a rate hike at the September FOMC meeting to 30% from 25% previously.

We see this phrase as a half step toward the ‘nearly balanced’ language the committee used to describe the outlook late last year, and an effective way to keep its options open for action as early as the September meeting. As a result, we have raised our subjective odds of a hike at the September meeting to 30% from 25% previously; we continue to see a 40% chance that the next hike will come in December—implying a roughly 70% probability of at least one rate increase this year.”

Peter Tchir, Brean Capital: Fed may “break with tradition and hike in the heat of the election cycle”

“[The] report seems to set the stage for a series of Fed Speakers to push on the need to hike rates…the next meeting will have the press conference and the election is already so convoluted that they might well break with tradition and hike in the heat of the election cycle …

For the past year a hawkish Fed has generally been bad for stocks and with the chase for yield dragging in dividend stocks of all sorts — the equity market is far more susceptible than usual to any back-up in treasury yields.

I think this further encourages you to ‘sit on your helmet’ during this alleged ‘helicopter’ ride.”

Capital Economics: “[W]e still expect the Fed to raise rates … probably twice this year”

“[T]he assessment that near-term risks have diminished, as well as Esther George’s decision to resume voting at this meeting for an immediate rate hike, make it clear that the odds of a September rate hike are far higher than the minor probability that was priced into futures markets.

Overall, we still expect the Fed to raise rates at least once and probably twice this year, taking the fed funds target range to between 0.75% and 1.00% by year-end.”

[j-underhill-blog]

This is the most positive Fed statement we've seen in a while

  The Federal Reserve once again left interest rates unchanged Wednesday, following its two-day policy meeting, citing an improving labor market and progress in economic growth.

The widely expected move comes amid mixed economic reports and after Fed officials agreed that it was “prudent to wait” for more data on the consequences of Britain’s June 23rd decision to leave the European Union. The Fed’s statement reiterated that it will “closely monitor” developments abroad.

For the first time this year, the Fed noted, “near-term risks to the economic outlook have diminished,” implying that officials are keeping their options open for a rate hike this year. The previous two Fed statements withheld mention of global economic risks, while the March statement warned that developments abroad “pose risks.”

“Today’s FOMC statement was more upbeat than the cheerless one released after the June meeting,” said Michael Feroli, JP Morgan chief US economist. “[T]he improved risk assessment could begin to lay the groundwork for a hike in a few meetings’ time, provided the data cooperate.”

The Fed’s cautious, yet generally positive, economic outlook notes “the labor market strengthened and that economic activity has been expanding at a moderate rate. Job gains were strong in June following weak growth in May. On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months.”

The statement follows mixed jobs reports in which the US economy added only 11,000 jobs in May, the lowest level in six years, but rebounded by 287,000 jobs in June, the strongest growth in 2016. Other employment data has been varied. The hiring rate has slowed, but jobless claims are near record lows. Fed officials have said that they are waiting for additional data before placing weight on recent employment numbers.

Meanwhile, inflation, which has run below the Fed’s 2% target for years, has shown signs of improvement in recent months, as oil prices stabilized. The personal consumption expenditures index, the Fed’s preferred measure of price inflation, increased 0.9% in May from the year before, as core inflation rose 1.6%. However, the Fed sees inflation remaining “low in the near term.”

With only three policy meetings remaining in 2016, expectations are low that the Fed will raise rates twice this year, as officials forecasted in June. Shortly after the Fed began lifting rates in December—for the first time in over a decade—turmoil in US markets and uncertainty abroad convinced many officials to delay further rate increases.

“At some point the Federal Reserve has to be willing to raise interest rates under a less-than-perfect set of conditions,” said Greg McBride, Bankrate’s chief financial analyst. “If they’re waiting for world peace and harmony before raising interest rates again, they’ll never do it.”

While the Fed decided hold its benchmark rate between 0.25%-0.50%, one member of the committee, Esther L. George, voted against the decision, preferring to raise the federal funds rate to 0.50% to 0.75% at this meeting.

“The July meeting is the setup for a potential rate hike in September,” wrote Chris Rupkey, chief financial economist at The Bank of Tokyo Mitsubishi. “The economy is better than Fed officials think. Rate hikes are coming. Bet on it.”

Redline version below.

Fed July statement redline