The end of forward guidance - Good, let's use rules

 

Recent comments from Fed Chairman Warsh suggest that he is not in favor of the current forms of forward guidance. No dot plots, or perhaps not in the current form. The Fed has proven to be a poor forecaster, so the guidance may not be helping the market. It does not make sense for Fed governors and presidents to give speeches on their views of the economy when most are wrong. Let’s not have the market hanging on guidance that may be wrong. 

I have always been in favor of having a more rules-based approach that provided clarity on the general direction of policy. Can there be deviations from the rules? Yes, but there have to be good reasons that are infrequent. Of course, many governors and presidents like to give speeches, so there has to be a change in the messages to the market.

Gold overtakes Treasuries as central bank reserves

 

From work done by the ECB, gold has now overtaken US Treasuries as the largest reserve asset for central banks. This is driven by the strong price appreciation of gold over the last year, even with the recent declines. US Treasuries have seen yields rise, reducing the value of the asset. This is not surprising, given the strong buying by central banks, especially over the last four years, amid rising inflation. Still, it suggests that central banks have less confidence in government debt as a safe asset.

Safety is relative, and from the perspective of central banks, it makes sense to hold an asset that is likely to preserve its value during periods of higher inflation. Is the inflation-gold link strong? Not really, but it does seem to be a better inflation hedge than bonds when an inflation shock is expected. Gold can earn some yield if it is leased, but generally there is no yield, whereas bonds may earn a positive real yield.  

Central banks are telling us they lack confidence in their ability to control inflation globally.

Forming better decisions through known, unclear, and presumed framework

 

This book, Thinking in Time: The Uses of History for Decision Makers is now 40 years old, yet it provides some good, simple insights on how to make better decisions. You may not be interested in the political stories provided, but they provide context on how best to use the Neustadt and May framework.

The method is defined as the K-U-P/L-D, or the known, unclear, and presumed, which is then used to compare with likeness and differences. 

Determine what is known, define what is unclear, and then assess what is presumed by the decision maker. The decision-maker should then look for likenesses and differences in history, which can be used to define what is now of concern and what will be new objectives. 

The authors suggest the Gldberg rule: don't ask "what is the problem?" Rather, ask, "What is the story?" by using a timeline from now to the start of the story.

Be a journalist and ask when, what, where, who, how, and why. 

While this is not a quantitative process, it can be useful for framing discussions. 

The current inflation divergence - trimmed mean versus core PCE

The preferred inflation measure for the Fed is core PCE. The idea behind using a core measure is that it filters out extremes that may be driven by supply shocks. Fed Chairman Warsh has a different preferred measure: the trimmed mean, which includes food and energy but removes extreme values, both high and low, from the inflation index. If food and energy are on the high end, those prices will be trimmed, but that need not be the case. 

History shows that the trimmed mean is smoother and will lag the core PCE, but now we are seeing something different: the core PCE is rising while the trimmed mean is falling. Which one you place more stock in will drive your decision on Fed action and the direction of rates.

There will be politics over whether Warsh will be able to get others on board with the trimmed-mean measure, and that will determine any Fed action.