Fed Warns “Valuation Pressures Have Increased Further” In Latest Monetary Policy Report
Moments ago the Fed released its July Monetary Policy Report which forms the basis of Janet Yellen’s testimony to Congress next week, and while it does not traditionally discuss monetary policy it does provide a snapshot of the Fed’s take of the economy and capital markets at any given moment. Here are some of the highlights courtesy of BBG:
- Federal Reserve says bond liquidity ample despite lower market-maker inventory, in monetary policy report in Washington.
- Fed sees little evidence of liquidity impairment in corp bonds
- Fed says financial markets recently performed well under stress
- Fed says financial system vulnerabilities stayed modest
- Fed notes liquidity mismatch at FHLBs as funding-strain risk
- Fed warns that valuation pressures are up in bonds, equities, com real estate
- Fed says term-premium rise poses downside risk to long bond prices
- Fed sees signs of tightening credit in commercial real estate
- Fed defends its opposition to rules-based monetary policy
And some further details, first on the the global productivity slowdown.
“Over the past decade, labor productivity growth both in the United States and in other advanced economies has slowed markedly. This slowdown may reflect a waning of the effects from advances in information technology in the 1990s and early 2000s. Productivity growth may also be low because of the severity of the Global Financial Crisis, in part because spending for research and development was muted. Some of the factors restraining productivity growth may eventually fade, but it is difficult to ascertain whether the recent subdued performance of productivity represents a new normal”
On labor markets and wage growth:
“The labor market has strengthened further so far this year. Over the first five months of 2017, payroll employment increased 162,000 per month, on average, somewhat slower than the average monthly increase for 2016 but still more than enough to absorb new entrants into the labor force. The unemployment rate fell from 4.7 percent in December to 4.3 percent in May—modestly below the median of FOMC participants’ estimates of its longer-run normal level. Other measures of labor utilization are also consistent with a relatively tight labor market. However, despite the broad-based strength in measures of employment, wage growth has been only modest, possibly held down by the weak pace of productivity growth in recent years.”
On education and climing the social ladder:
“Education, particularly a college degree, is often seen as a path to improved economic opportunities. However, despite the fact that young blacks and Hispanics have increased their educational attainment over the past quarter-century, their representation in the top 25 percent of the income distribution for young people has not materially increased. In part, this outcome has occurred because educational attainment has increased for young non-Hispanic whites and Asians as well. While education continues to be an important determinant of whether one can climb the economic ladder, sizable differences in economic outcomes across race and ethnicity remain even after controlling for educational attainment.”
On ecomomic growth:
“Real gross domestic product (GDP) is reported to have risen at an annual rate of about 1½ percent in the first quarter of 2017, but more recent data suggest growth stepped back up in the second quarter. Consumer spending was sluggish in the early part of the year but appears to have rebounded recently, supported by job gains, rising household wealth, and favorable consumer sentiment. Business investment has turned up this year after having been weak for much of 2016, and indicators of business sentiment have been strong. The housing market continues its gradual recovery. Economic growth has also been supported by recent strength in foreign activity.”
On the risk of a spike in term premiums (i.e., if central banks stop buying):
“Term premiums on Treasury securities continue to be in the lower part of their historical distribution. A sudden rise in term premiums to more normal levels poses a downside risk to long-maturity Treasury prices, which could in turn affect the prices of other assets.”
On liquidity in corporate bond markets:
“A series of changes, including regulatory reforms, since the Global Financial Crisis have likely altered financial institutions’ incentives to provide liquidity. Many market participants are particularly concerned with liquidity in markets for corporate bonds. However, the available evidence suggests that financial markets have performed well in recent years, with minimal impairment in liquidity, either in the market for corporate bonds or in markets for other assets.”
On balance sheet policy:
“To help maintain accommodative financial conditions, the Committee has continued its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and rolling over maturing Treasury securities at auction. In June, the FOMC issued an Addendum to the Policy Normalization Principles and Plans that provides additional details regarding the approach the FOMC intends to follow to reduce the Federal Reserve’s holdings of Treasury and agency securities in a gradual and predictable manner. The Committee currently expects to begin implementing the balance sheet normalization program this year provided that the economy evolves broadly as anticipated.”
And last but not least, the usual warning about high asset values:
Valuation pressures across a range of assets and several indicators of investor risk appetite have increased further since mid-February. However, these developments in asset markets have not been accompanied by increased leverage in the financial sector, according to available metrics, or increased borrowing in the nonfinancial sector. Household debt as a share of GDP continues to be subdued, and debt owed by nonfinancial businesses, although elevated, has been either flat or falling in the past two years.
Maybe not in the financial sector, but these development have been accompanied by a material increase in leverage in the public sector, the same sector which will soon see substantial deleveraging if central banks are to be believed.
Full report below (link):