Knight Reading

by CC July 13, 2011 12:11 am • Commentary



  • 7:00 a.m. ET all times: MBA mortgage applications data are due. Nobody’s taking out mortgages any more, so.
  • 8:30 a.m.: Export and import price data for June are due, for those who want to sleep in a little late.


  • 9:10 a.m.: Boston Fed President Eric Rosengren, who doesn’t have a policy vote this year, speaks at a conference.
  • 10:00 a.m.: Fed Chairman Ben Bernanke delivers the old Humphrey-Hawkins song and dance to the House and then subjects himself to hours of questioning.
  • 1:20 p.m.: Dallas Fed President Richard Fisher, who has a policy vote this year, will shriek the cry of the hawk at the Rotary Club in Dallas.

Earnings: We get reports from:

  • Yum Brands
  • Marriott

The Federal Reserve

–To begin the process of policy normalization, the Committee will likely first cease reinvesting some or all payments of principal on the securities holdings in the SOMA.

–At the same time or sometime thereafter, the Committee will modify its forward guidance on the path of the federal funds rate and will initiate temporary reserve-draining operations aimed at supporting the implementation of increases in the federal funds rate when appropriate.

–When economic conditions warrant, the Committee’s next step in the process of policy normalization will be to begin raising its target for the federal funds rate, and from that point on, changing the level or range of the federal funds rate target will be the primary means of adjusting the stance of monetary policy. During the normalization process, adjustments to the interest rate on excess reserves and to the level of reserves in the banking system will be used to bring the funds rate toward its target.

–Sales of agency securities from the SOMA will likely commence sometime after the first increase in the target for the federal funds rate. The timing and pace of sales will be communicated to the public in advance; that pace is anticipated to be relatively gradual and steady, but it could be adjusted up or down in response to material changes in the economic outlook or financial conditions.

–Once sales begin, the pace of sales is expected to be aimed at eliminating the SOMA’s holdings of agency securities over a period of three to five years, thereby minimizing the extent to which the SOMA portfolio might affect the allocation of credit across sectors of the economy. Sales at this pace would be expected to normalize the size of the SOMA securities portfolio over a period of two to three years. In particular, the size of the securities portfolio and the associated quantity of bank reserves are expected to be reduced to the smallest levels that would be consistent with the efficient implementation of monetary policy.

–The Committee is prepared to make adjustments to its exit strategy if necessary in light of economic and financial developments.


Federal Reserve policy makers disagreed on whether additional monetary stimulus will be needed even if the outlook for economic growth remains weak, minutes of their meeting last month showed.

“A few members noted that, depending on how economic conditions evolve, the committee might have to consider providing additional monetary stimulus, especially if economic growth remained too slow to meaningfully reduce the unemployment rate in the medium run,” the Federal Open Market Committee said in the minutes of its June 21-22 meeting, released today in Washington.

“On the other hand, a few members viewed the increase in inflation risks as suggesting that economic conditions might well evolve in a way that would warrant” the FOMC “taking steps to begin removing policy accommodation sooner than currently anticipated.”


Chinese industrial production advanced 15.1 percent in June from a year earlier, compared with the 13.1 percent median estimate of economists in a Bloomberg survey. Gross domestic product increased 9.5 percent in the second quarter, compared with 9.7 percent in the previous three months and the 9.3 percent analysts surveyed by Bloomberg had been expecting. The yuan strengthened 0.04 percent to 6.4697 per dollar.


A main gauge of stress in the credit market shows increasing worries about counterparty risk as the eurozone debt troubles increasingly threaten to spill over into larger economies.

The two-year US swap spread earlier widened to 31.25 bps, its widest level since 31.5 bps on July 13, 2010. It recently trades at 29.75 bps, 1.25 bps wider than late Monday’s level.

Swap spreads often move in tandem with credit spreads and are a sign that traders think their partners in an interest-rate swap trade will fail to hold up their end of the trade.

Pragmatic Capitalism

The Great Recession triggered a dramatic shift in household spending behavior. Real personal consumption expenditures trended down for six quarters, the personal saving rate more than tripled from around 2% to over 6%, and households began a sustained deleveraging process that is still under way (see Glick and Lansing 2009).

This Economic Letter estimates the amount of consumption lost from the Great Recession by comparing the actual trajectory of real personal consumption expenditures to its pre-recession trend. The amount turns out to be quite large. From December 2007 through May 2011, foregone consumption per person was over $7,300, or about $175 per person per month.”

Calculated Risk

Here is what I wrote two months ago:

Congress will probably push this to the brink, but they will raise the debt ceiling before the country defaults. The first rule for most politicians is to get re-elected, and the easiest way to guarantee losing in 2012 is to throw the country back into recession. If that happened, I believe the voters would correctly blame the leaders of Congress, and I think Congress knows that too. Therefore it won’t happen. I’m not worried and neither are investors.

We are almost to the “brink”.

Let me add: In this case, voters would blame the Republican party, and if the debt ceiling is not raised, the “Republican” brand would become toxic and synonymous with fiscal irresponsibility. The leaders of Congress know that and they will scramble to find a solution. I doubt this is the end of the GOP 🙂

Early I argued the smart thing to do would be to eliminate the debt ceiling. Maybe we are headed in that direction. Today, Senator Mitch McConnell proposed something along those lines (not clean though).

Senate Minority Leader Mitch McConnell (R., Ky.) unveiled a new proposal that would allow President Barack Obama to raise on his own the federal borrowing limit by $2.4 trillion in three installments before the end of 2012, unless two-thirds of Congress votes to block it.

Somehow the debt ceiling will be raised. Of course there is a huge battle ahead over the budget for the next fiscal year (the fiscal year starts on October 1st). It never ends.