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Coronavirus Freaked Markets, Not the Fed (Chapter 8)

By Bill Dudley, February 25, 2020

The U.S. equity market finally is taking notice of the coronavirus, which now is spreading from China to other countries and increasing the risk of a shock that could cause a U.S. recession. So what are the implications for the U.S. economy and the Federal Reserve? Obviously, that is a difficult question to answer because it's impossible to anticipate what comes next.

That said, policy makers need to consider the potential impact, which as I see it has two distinct elements.

The first is the impact on economic activity where cases are most prevalent, such as China, Singapore, South Korea and, most recently, northern Italy. Here there are consequences for both supply and demand. Output is falling as factories close to keep people from congregating and spreading the virus. Demand is falling as people stay home. That means a drop in leisure activity and retail sales, especially for items for which purchases can be deferred, such as motor vehicles.

The second is the impact on economic activity elsewhere. Here there also are demand and supply effects. Travel from the affected areas is being sharply limited to prevent the further spread of the virus. This hurts hotels and airlines. Production will decline as disruption to global supply chains leads to spot shortages of critical inputs; you can't build a car unless you have all of the parts. In thinking about how powerful these impacts could be, one might assess the effect on economic activity from the direct impacts versus the indirect ones because of the effect on public sentiment.

The direct impact depends on the number of people infected, the mortality rate and the breadth of the nations where outbreaks occur. The indirect impact is how people react. For example, will travelers refuse to go to Asia? That depends, of course, on the severity of the epidemic, but it also depends on people's risk aversion. This effect is perhaps the most difficult to judge. Modern experiences with epidemics are limited. Moreover, every experience is different in terms of prevalence and virulence. I suspect that 100,000 cases in one city probably would have much less impact than 100,000 cases spread widely around the world. So how should the Fed respond given the high degree of uncertainty?

Most likely, the Fed will wait a while longer before considering interest-rate cuts. After all, the harm to the U.S. economy remains mostly speculative at this stage. But it won't take much more bad news for Fed officials to signal that they are prepared to act. More economic data about Chinese economic growth, imports and exports, and the impact on U.S. manufacturing eventually will become available. This will be important in shaping Fed policy makers' views. The greatest risk to the record U.S. economic expansion is an external shock that the Fed can't offset because it responds either too late or without enough force. This risk is rising.

Fed officials recognize that it doesn't take a particularly big shock to push the U.S. into recession. When the dynamic of the economy turns negative, the feedback loop from a drop in demand on production, employment, income and sentiment can be quite powerful. This may be particularly relevant right now; the economy doesn't have much forward momentum and sentiment probably is fragile in the face of a growing risk of a global pandemic.

If the situation stays roughly the same or deteriorates further, I would expect Fed officials to take note of the risks in their next Federal Open Market Committee policy statement and for Chair Jerome Powell to make it clear in his press conference that the Fed is alert and prepared to respond forcefully should that prove necessary. This view is consistent with what is priced into the federal funds futures market; the market anticipates about 60 basis points, or 0.60%, of rate cuts during the next year. But expectations also indicate that the Fed wants to wait and gather more information. For now, that seems like the right view.

Bill Dudley is a senior research scholar at Princeton University's Center for Economic Policy Studies. He served as president of the Federal Reserve Bank of New York from 2009 to 2018, and as vice chairman of the Federal Open Market Committee. He was previously chief U.S. economist at Goldman Sachs.

2020 Bloomberg L.P.

Fed stresses its commitment to low rates as economy stumbles

By CHRISTOPHER RUGABER and MARTIN CRUTSINGER 1/27/2021

WASHINGTON (AP) Chair Jerome Powell said Wednesday that the Federal Reserve will keep pursuing its low-interest rate policies until an economic recovery is well underway, acknowledging that the economy has faltered in recent months.

The Fed said in a statement(Links to an external site.) after its latest policy meeting that hiring and economic growth had slowed, particularly in industries affected by the raging pandemic, notably restaurants, bars, hotels and others involving face-to-face public contact. The officials kept their benchmark short-term rate pegged near zero and said they would keep buying Treasury and mortgage bonds to restrain longer-term borrowing rates and support the economy. Speaking at a news conference, Powell made clear his belief that the economy will struggle in the coming weeks and months, until widespread vaccinations and government rescue aid eventually fuel a sustained rebound. "We're a long way from full recovery," he said. "Something like 9 million people remain unemployed as a consequence of the pandemic. That's as many people as lost their jobs at the peak of the global financial crisis and the Great Recession."

The Fed statement warned that the virus is posing risks to the economy. But the officials removed phrases from their previous statement in December that had said the pandemic was pressuring the economy in the "near term" and posed risks "over the medium term." Powell said that language was removed because the Fed policymakers see the pandemic increasingly as a short-term risk that will likely fade as vaccines are distributed more widely. But he also cautioned that the threat remains a serious one, particularly because of the potential harm from new strains of the virus. "We have not won this yet," Powell said. "There's nothing more important to the economy now than people getting vaccinated."

As Powell spoke, a broad sell-off on Wall Street(Links to an external site.)knocked more than 600 points off the Dow Jones Industrial Average, handing the stock market its worst day in nearly three months. The drop, which followed a recent record-setting run, came as investors focused on the uncertain outlook for the economy and corporate profits amid a still-raging coronavirus pandemic. Traders were also focused on the eye-popping surge in shares of GameStop(Links to an external site.), a money-losing video game seller that became the focus of a battle between small investors bidding it higher and big hedge funds betting it would fall. For now, the job market is faltering, with 9.8 million jobs still lost to the pandemic, which erupted 10 months ago. Hiring has slowed for six straight months, and employers shed jobs in December(Links to an external site.) for the first time since April. The job market has sputtered as the pandemic and colder weather have discouraged Americans from traveling, shopping, dining out or visiting entertainment venues. Retail sales have declined for three straight months.(Links to an external site.)

Yet the Fed still envisions a sharp rebound in the second half of the year as the virus is brought under control by vaccines and government-enacted rescue money spreads through the economy. Americans fortunate enough to have kept their jobs have stockpiled massive savings that suggest pent-up demand that could be unleashed, with a big lift to the economy, once consumers increasingly feel safe about resuming their old spending patterns. Powell was pressed during the news conference on whether the Fed should respond to the recent speculative surge in the prices of some individual stocks, notably shares of GameStop, and whether that buying frenzy suggested a dangerous bubble in overall stock prices. Powell deflected the questions by saying the Fed's interest rate policies aren't well-suited to address speculation in the stock market. In addition, he said, "if you look at what's really been driving asset prices in the last couple of months, it isn't monetary policy. It's expectations about vaccines and also fiscal policy. Those are the news items that have been driving asset values in recent months." Powell also noted that the Fed is keeping rates low and buying bonds to support economic growth. Reversing those policies to offset potential bubbles in the stock market, he said, could harm the economy. "We don't actually understand the trade-off," he said. "Will it actually cause more damage, or will it help? I think that's unresolved."

The Fed has signaled that it expects to keep its key short-term rate at a record low between zero and 0.25% through at least 2023. Earlier this month, Vice Chair Richard Clarida said he expects the Fed's bond purchases to extend through the end of this year, which would mean continued downward pressure on long-term loan rates. The central bank said it will continue its bond purchases until it makes "substantial further progress" toward its goals of maximum employment and stable 2% inflation. Powell said "it is likely to take some time" for that progress to be achieved.

The Fed's drive to keep long-term rates low have helped hold down mortgage rates and fueled home sales and price increases. Home prices, for example, surged 9% in November compared with a year earlier, its fastest increase in more than six years. The prospect of significant more government rescue aid and ongoing vaccinations has raised some concern that as Americans eventually release pent-up demand for airline tickets, hotel rooms, new clothes and other goods and services, the economy might accelerate and annual inflation could surge above the Fed's 2% target.

If many companies don't initially have the capacity to meet that demand, prices would pick up. Powell, however, dismissed those concerns, pointing to several long-run factors that have restrained inflation for more than a decade, such as an aging population that tends to spend less and save more, technological developments that improve efficiency, and overseas competition. "Frankly, we welcome somewhat higher inflation," Powell said. The Fed believes that inflation sustainably at 2% guards against deflation, a drop in prices and wages. And since interest rates include expected levels of inflation, that gives the Fed more room to cut interest rates. "The kind of troubling inflation that people like me grew up with seems far away and unlikely." The Fed adopted a framework last year that calls for inflation to average 2% over time. Given that inflation has mostly languished below that level since the Fed adopted it as a target in 2012, policymakers would have to let inflation run above 2% for some time to make up for the years of below-target price increases.

https://apnews.com/article/fed-low-rates-coronavirus-economy-a142da0b3bac10860247732cdc2a7acf

These Coins Cost More to Make than They're Worth

By Team Wall Street Survivor(Links to an external site.)(Links to an external site.) February 29, 2016

What's in there? A half-eaten pack of gum, afew dollar notes, some crumbs from your morning bagel?Maybe even some coins?

Have you ever taken a second to consider how that money got there? Like...who makes the money that we all use to buy hot pockets or whatever? The U.S. dollar banknotes come from the Bureau of Engraving and Printing, while all the coins in circulation are produced by the U.S. Mint. What's strange is that two of the coins currently in circulation cost more to make than their actual face value.

Both the nickel and penny cost more to make than they are worth.

A quarter, worth 25, only costs 9 to make while a dime only costs about 4. On the other hand...a penny costs 1.66. The nickel, with a face value of 5, costs 8 to produce!

As you can see from the above graph, the nickel and the penny aren't worth the metal they're minted on. While the falling price of copper in recent times has given the U.S. mint a bit of a discount, it still hasn't done enough for them to be able to turn a profit (so to speak). It seems so obvious,but not many people think about the fact that someone had to pay to make the money that we use. Like economists say...there's no such thing as a free lunch. While we use money without much (if any) thoughtto the costs that were incurred to produce it, those costs are still there. Very much there, actually. It hurts even more when you consider that it's the taxpayer who pays for the coins to be minted. Yep. That means you.

When you add it all up...U.S. taxpayers are losing $100 million a year from making these nickels and pennies. All due to the costof the metalsused in the minting of said coins. The falling price of copper and zinc in recent years does mean thatwe got a bit of a break, though. Because as recently as 2011, it cost 2.4 cents to make a penny. Ouch. Also...what?!?! That means in 2011, if you paid someone in pennies, they could melt those coins down and sell it for more than twice what they received. So whydo we still keep them around?

After reading this...you might be moved to ask why we don't just get rid of the penny and nickel. After all, inflation(Links to an external site.)(Links to an external site.) has rendered their buying power almost useless. Think about it, would you ever stop to pick up a penny that you spotted on the floor? Chances are you wouldn't even notice it, let alone break your stride for it. In fact, the only time most Americans use pennies and nickels is when it's time to break open the piggy bank and head on down to the local Coinstar so you can get some crisp bills in exchange.

So why are they still around?

There a few reasons out there. Some say that people are attached to the coins, citing polls and quoting people who talk about the historical importance of the coins. Still, others consider the tribute to Lincoln (his face is on the penny, you guys!) as another reason...but given that he's also on the $5 dollar bill we are of the opinion that Honest Abe has his hands in enough pies. There's likely a better reason. The alternatives are not very appealing for some people. You could theoretically just alter how much copper and zinc is in each of the coins - up to a point where you start to "turn a profit" on producing them. If a penny is currently made of 80% copper, then maybe if we diluted that down to 50% we could trim down on production costs sufficiently.

That's an easy solution on the production side. The problem is that there's a big lobby, made up of metal alloy industries and vending machine corporations, who oppose it. Buying less metal means less money for the alloy industries. The biggest pro-penny lobby group is called Americans for Common Cents and is backed by a major zinc producer. How convenient. Meanwhile, changing the weight of the coins would necessitate the upgrading of all the vending machines in the country - a costly endeavor estimated to run in the billions of dollars. That's a cost that the vending machine industry would obviously not like to have to endure...so they'll fight. Hard.

Another option is to just get rid of it entirely. That's what other countries, like Canada and Australia, have done and makes a lot of sense. Instead of using pennies, the price of a purchase is either rounded up or down. $20.03 for a pair of gloves becomes $20 and $20.08 becomes $20.10. On some purchases, you'll pay a few extra pennies and on others you'll make a few pennies. Unlike your college roommate who "never carries cash!", this oneevens out in the long run.

There are those who believe that eliminating the penny and/or nickel would cause prices to rise. Merchants will pinch a penny here and a penny there - making everything slightly more expensive to buy. In a poll conducted in 2012, more than two-thirds of respondents were under the impression that a rounding system like the one implemented in Canada would cause businesses to raise prices.

Like it or not, it's the taxpayer's perception of what might happen as well as the strength of certain lobbying agents that is keeping the penny in circulation. So while the penny was probably useful when it was first introduced in 1864 - back when a dozen eggs cost less than 30c - now it's more useful as a paperweight (if you have enough of them).

http://blog.wallstreetsurvivor.com/2016/02/29/these-coins-cost-more-to-make-than-theyre-worth/(Links to an external site.)(Links to an external site.)

How Treasury Auctions Work

Marketable securities can be bought, sold, or transferred after they are originally issued. The U.S. Treasury uses an auction process to sell these securities and determine their rate or yield. Annual auction activity:

• Offers 4 types of securities(Links to an external site.)(Links to an external site.) with varying maturities
• Conducts approximately 200 public auctions
• Issues more than $4.2 trillion in securities

To finance the public debt, the U.S. Treasury sells bills, notes, bonds, and Treasury Inflation-Protected Securities (TIPS) to institutional and individual investors through public auctions. Starting in February 2006, Treasury resumed the auction of Treasury bonds. Treasury auctions occur regularly and have a set schedule. There are three steps to an auction: announcement of the auction, bidding, and issuance of the purchased securities.

Announcement

The auctions are announced in advance in most major newspapers and through press releases. Once an auction is announced, your institution may submit a bid for the security. You may bid directly through Legacy Treasury Direct (except for 30-year bonds and 20-year TIPS which are not available in Legacy Treasury Direct starting in January 2007), TAAPS (with an established account), or make arrangements to purchase securities through a broker, dealer, or other financial institution. The auction announcement details:

• Amount of the security Treasury is selling
• Auction date
• Maturity date
• Terms and conditions of the offering
• Customers eligible to participate
• Noncompetitive and competitive bidding close times
• Other pertinent information

View upcoming auction announcements(Links to an external site.)(Links to an external site.). Detailed information about U.S. Treasury announcements is available in the Code of Federal Regulations (CFR) at 31 CFR Part 356(Links to an external site.)(Links to an external site.).

Bidding

When participating in an auction, there are two bidding options - competitive and noncompetitive.

• Competitive bidding is limited to 35% of the issue amount for each bidder, and a bidder specifies the rate or yield that is acceptable.
• Noncompetitive bidding is limited to purchases of $5 million for U.S. Treasury bills, notes, bonds, and TIPS. With a noncompetitive bid, a bidder agrees to accept the rate or yield determined at auction.
• Bidding limits apply cumulatively to all methods that are used for bidding in a single auction.

For institutional investors, please note that Legacy Treasury Direct allows noncompetitive bidding only and does not offer 30-year bonds or 20-year TIPS.

At the close of an auction, Treasury accepts all noncompetitive bids that comply with the auction rules and then accepts competitive bids in ascending order in terms of their yields until the quantity of accepted bids reaches the offering amount. All bidders will receive the same rate or yield at the highest accepted bid.

All auctions are open to the public. The following U.S. Treasury services are available:

• Individuals: TreasuryDirect accounts(Links to an external site.)(Links to an external site.)
• Individuals and Institutions: Legacy Treasury Direct accounts(Links to an external site.)(Links to an external site.)
• Institutional Investors: TAAPS(Links to an external site.)(Links to an external site.)

Read the relevant auction regulations(Links to an external site.)(Links to an external site.) and the Treasury Securities Offering Announcement Press Release(Links to an external site.)(Links to an external site.) to find out if your institution may participate.

Issuance

• On issue day, the Treasury delivers securities to bidders who were successfully awarded securities in a particular auction. In exchange, Treasury charges the accounts of those bidders for payment of the securities.
• Treasury bills are issued at a discount from face value and are paid at their par (face amount) at maturity. The purchase price is listed on the auction results press release and is expressed as a price per hundred dollars.
• Treasury notes, bonds, and TIPS are issued with a stated interest rate applied to the par amount and have semiannual interest payments. For TIPS, the interest payments and the final payment at maturity are based on the inflation-adjusted principal value of the security. In some cases, the purchaser may have to pay accrued interest.

General Auction Timing

The following is the current pattern of financing for marketable U. S. Treasury bills, notes, bonds, and TIPS. Treasury borrowing requirements, financing policy decisions, and the timing of Congressional action on the debt limit could alter or delay the pattern.

I. Treasury Bills(Links to an external site.)(Links to an external site.)

• 4-week bills are offered each week. Except for holidays or special circumstances, the offering is announced on Monday, the bills are auctioned the following Tuesday, and they are issued on the Thursday following the auction.
• 13-week and 26-week bills are offered each week. Except for holidays or special circumstances, the offering is announced on Thursday, the bills are auctioned the following Monday, and they are issued on the Thursday following the auction.
• Cash Management bills are offered from time to time, depending on borrowing needs. The time between announcement, auction, and issue is usually brief (1-7 days).

II. Treasury Notes(Links to an external site.)(Links to an external site.)

• 2-year note auctions are usually announced on the third or fourth Monday of each month and generally auctioned two days later. They are issued on the last day of the month. If the last day of the month is a Saturday, Sunday, or federal holiday, the securities are issued on the first business day of the following month.
• 5-year note auctions are usually announced on the third or fourth Monday of each month and generally auctioned three days later. They are issued on the last day of the month. If the last day of the month is a Saturday, Sunday, or federal holiday, the securities are issued on the first business day of the following month.
• 10-year note auctions are usually announced on the first Wednesday in February, May, August, and November. The reopening of 10-year note is usually announced at the beginning of March, June, September, and December. All 10-year notes are generally auctioned during the second week of the above-mentioned months and are issued on the 15th of the same month. If the 15th falls on a Saturday, Sunday, or federal holiday, the securities are issued on the next business day.

III. Treasury Bonds(Links to an external site.)(Links to an external site.)

• 30-year bonds are usually announced on the first Wednesday in February and August. The reopenings of 30-year bonds is usually announced on the first Wednesday in May and November. All 30-year bonds are generally auctioned during the second week of the above-mentioned months and are issued on the 15th of the same month. If the 15th falls on a Saturday, Sunday, or federal holiday, the securities are issued on the next business day.

IV. Treasury Inflation-Protected Securities (TIPS)(Links to an external site.)(Links to an external site.)

• 5-year TIPS are usually announced the third week of April. The reopening of 5-year TIPS is usually announced the third week of October. All 5-year TIPS are generally auctioned the last week of the above-mentioned months and are issued on the last business day of the month. However, these TIPS will continue to have a midmonth maturity date. Therefore, investors who purchase these securities at auction will be required to pay the interest accrued between the 15th of the month and the issue date.

Note: 5-year TIPS issued in October 2004 will have an initial maturity of 5-1/2 years and will be reopened in April 2005 and October 2005.

• 10-year TIPS are usually announced at the beginning of January and July. The reopening of 10-year TIPS is usually announced at the beginning of April and October. All 10-year TIPS are generally auctioned the second week of the above-mentioned months and are issued on the 15th of the same month. If the 15th falls on a Saturday, Sunday, or federal holiday, the securities are issued on the next business day.
• 20-year TIPS are usually announced the third week of January. The reopening of 20-year TIPS is usually announced the third week of July. All 20-year TIPS are generally auctioned the last week of the above-mentioned months and are issued on the last business day of the month. However, these TIPS will continue to have a mid-month maturity date. Therefore, investors who purchase these securities at auction will be required to pay the interest accrued between the 15th of the month and the issue date.

Note: The 20-year TIPS issued in July 2004 will have an initial maturity of 20-1/2 years and will be reopened in January 2005 and July 2005.