David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok’s articles and financial market commentary have appeared in The New York Times, The Wall Street Journal, Barron’s, and other publications. He is a frequent contributor to CNBC programs. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).
November 4, 2009
In response to the recent piece we wrote about the Fed and the unemployment rate, Bloomberg anchor Kathleen Hays emailed the following: [Richmond Fed president] “Jeff Lacker told me he could see the Fed tightening before unemployment comes down when I interviewed him last month on The Hays Advantage.”
Kathleen also sent a recent NY Fed staff report (number 397) entitled “Monetary Tightening Cycles and the Predictability of Economic Activity.” We thank her for this response and we have posted the NY Fed staff study on our website, www.cumber.com. Also there is our original October 31 commentary.
We have several items to raise for discussion.
The NY Fed study seems to examine a separate issue than the study we cited. The authors looked at the unemployment rate AFTER the Fed had stopped tightening. In our view that may be helpful from a policy-issue perspective but it does not help us to determine whether the Fed will start to raise rates BEFORE the unemployment rate peaks.
As portfolio managers we are concerned with the latter. Academics can use the former to debate the efficacy of Fed policy making. We do not have that luxury. We must spend our days managing clients’ money in real time, not debating policy outcomes after the fact. We have to deal with what the policy is doing or will do to the financial markets. When government gets it wrong, which they often do, it is our clients who will pay the price for their errors.
Jeff Lacker’s comments are significant. He is an independent thinker on the Federal Open Market Committee (FOMC) and has expressed dissent from Fed Chairman Bernanke in the past. He is often characterized as one of the “hawks” among the presidents. Suffice it to say the hawks have been more vocal recently, although they are each speaking as individuals and not arguing with a collective voice.
Lacker is also the current chairman of the conference of 12 Fed regional bank presidents. This is an annual and rotating position among the twelve Fed regional banks. The conference of presidents meets regularly to discuss operational and administrative issues in the Fed. They reportedly avoid discussion of monetary policy in deference to the FOMC gathering. Their meetings do not receive high-profile attention, and the documents circulated are internal.
Since the Fed presidents only have five voting at any given FOMC meeting, they are not deemed to be under the sunshine rules when they meet. The FOMC is supposed to have a total of twelve voting; of course, this requires that there be seven sitting governors. We have written about how politics is holding up a full board of governors, which is why there are only five at this time.
We have no way to know what the regional bank presidents discuss when they assemble privately. They make individual speeches and comments but are not known to publicly express a collective presidents’ view that is independent of the Board of Governors. In our view this is a mistake. Maybe there would be a healthier policy debate if the presidents combined into a coalesced body and offered a policy view of their own. Maybe we would be much better off if we followed the British system, wherein every member of the market committee has to testify before Parliament and explain their votes on policy? In America we only see Chairman Bernanke speaking for the FOMC. And we occasionally see a governor in front of Congress. When is the last time you can remember a Fed president testifying and explaining his or her policy decision in front of Barney Frank’s or Christopher Dodd’s Congressional committee?
Anyway, we go back to the Fed and the unemployment rate.
We argue that the Fed is not likely to raise the policy-setting interest rate until after the unemployment rate has clearly peaked. Our backup is a study done by David Hale. In that paper, Hale identified nine post-World War II periods in which the Fed started a tightening cycle after the unemployment rate peaked.
The series starting months are: December 1954, August ‘58, February ‘62, April ‘71, June ‘75, September ‘80, June ‘83, February ‘94, and June ‘04. The average time from unemployment rate peak to first tightening was six months. Hale’s sources are the Bureau of Labor Statistics and the Fed’s public records. Hale found that sometimes the first hike came as soon as one month after the unemployment rate peaked. Other times it was as long as 20 months after. But in every case it was AFTER and not BEFORE the peak in unemployment.
Is Jeff Lacker calling for an exception to this long-standing Fed tendency? We do not know, but we doubt it. It is unlikely that he or any of his colleagues will initiate a tightening cycle as long as inflation indicators remain as low as they are today. It is hard to see the Fed acting while the employment situation is deteriorating.
More likely, the Fed will wait until it is confident that the economy has commenced on a sustainable recovery path. Then it will start a tightening cycle that may be different from what we last saw under the Greenspan Fed. When this occurs we expect the Fed Funds rate to be adjusted in a less predictable fashion than Greenspan’s regular and systematic 1/4-point rate hikes that we witnessed in the early part of this decade.
The FOMC statement just released affirmed this outlook. We expect the Fed to continue the targeted zero to 25-basis-point Fed Funds rate for an “extended period.” They just said that’s what they will do. We believe they mean it. Please note that the vote was unanimous and included Jeff Lacker.
By Monday we will be in our first meeting in Tokyo. There we will raise the issue of whether or not the new government in Japan will proactively expand the Bank of Japan balance sheet and alter the form of the policy that the old government applied for years without success. In Japan, two members of the government sit on the monetary policy committee. Now that is political intervention.
David R. Kotok, Chairman and Chief Investment Officer, email: email@example.com