The Mechanics of Finance: The Federal Reserve with Komal Sri- Kumar

7/27/2019 The Mechanics of Finance: The Federal Reserve with Komal Sri- Kumar.

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M A N AG I N G T H E M O N E Y S U P P LY

M I L K E N I N S T I T U T E C E N T E R F O R F I N A N C I A L M A R K E T S

N AT I O N A L P R E S S F O U N D A T I O N

T U E S D A Y, J A N U A R Y 1 4 , 2 0 1 4

Mechanics of Finance: The Federal Reserve


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Overview2

Introduction 2

Crises and Fed Actions 5

Impact on markets 10

Global Action and Impacts 21 Tapering 30


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Monetary policy and the federal funds market

3

Normal Operations Quantitative Easing

Source: JPMorgan, Milken Institute

Interest

rates

Quantity of Bank Reserves

Tighten Ease

Fed

funds

rate

Bank Reserves Supply

Bank Reserves Demand

Interest

rates

Quantity of Bank Reserves QE zone




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Alternatives to QE

4

Floor System Corridor System

Excess money is soaked up at centralbanks borrowing facility

Borrowing and lending facility used toensure target rates stay in the corridor

Source: JPMorgan, Milken Institute

Interest

rates


Deposit

rateBank Reserves Demand



Deposit

rate

Ff rate

Lending

rate

Quantity of money




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Overview5

Introduction 2





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Fed Balance Sheet

6

Source: ISI Group


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Composition of Feds Balance Sheet

7

Sources: Federal Reserve, Milken Institute


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The Fed has engaged in Quantitative Easingrepeatedly

8



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Federal Reserves earning remittances to U.S.Treasury

9

Source: Federal Reserve

0

20

40

60

80

100

1952 1958 1964 1970 1976 1982 1988 1994 2000 2006 2012

US$ billions Federal reserve annual distributions to the U.S. Treasury


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Overview10

Introduction 2





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Has the U.S. policy rate been kept too low for toolong?

11

Sources: Federal Reserve, Bloomberg, Milken Institute


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U.S. economy is still below its potential output trend

12

10,000

11,000

12,000

13,000

14,000

15,000

2000 2002 2004 2006 2008 2010 2012

Real GDP (US$ billions, 2005=100)

Potential real GDP

Real GDP

Sources: U.S. Bureau of Economic Analysis, Federal Reserve Bank of St. Louis


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Employment To Population Ratio

13

58%

59%

60%

61%

62%

63%

64%

EmploymenttoPopu

lationRate%

58.6%

Employment growth is flat

Source: Bureau of Labor Statistics


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Unemployment

14

Source: Bureau of Labor Statistics

0

2

4

6

8

10

12

2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

Unemployment rate

7.0%


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Housing Stats Have Improved

15

Source: US Department of Commerce

400

700

1,000

1,300

1,600

1,900

2,200

2,500

2,800

HousingStartsSAARThousan

ds

1,036,000

Average

1,472,000

But have a long way to go


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U.S. private capital formation has not been picked up

16

Sources: U.S. Bureau of Economic Analysis, Milken Institute

0

1

2

3

4

5

1951 1957 1963 1969 1975 1981 1987 1993 1999 2005 2011

Net private fixed asset stock, four-year percent change at an annual rate (%), index, 2005=100


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Real treasury yield has turned negativein some recent periods

17

Sources: Federal Reserve, U.S. Bureau of Labor Statistics

-6

-4

-2

0

2

4

6

8

10

1957 1961 1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009 2013

U.S. real 10-year treasury yield, percent


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Relationship between Treasury yield and Fedsbuying Treasury securities

18

0

1

2

3

4

5

6

0.0

0.4

0.8

1.2

1.6

2.0

2005 2006 2007 2008 2009 2010 2011 2012 2013

US$ trillions Percent

QE1 QE2 QE310-year Treasury yield (%, RHS)

Fed holdings of Treasurysecurities (US$ trillions, LHS)



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Yields on U.S. high-yield bond hit record low

19

Source: Datastream

Note: BOFA MLUS High Yield Master II Index

0

5

10

15

20

25

1986 1989 1992 1995 1998 2001 2004 2007 2010 2013

Yield,%


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Total U.S. credit market debt

20

Sources: Federal Reserve, BEA

0

0.5

1

1.5

2

2.5

3

3.5

4

0

10

20

30

40

50

60

1949 1956 1963 1970 1977 1984 1991 1998 2005 2012

DebttoGDPR

atio

US$trillio

ns

Total credit market debt owed GDP Debt to GDP Ratio

Debt to GDP ratio

(1950-1980): 1.5

Debt to GDP ratio

(2012): 3.5+


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Overview21

Introduction 2





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Central bank target interest rates remain low

22

Source: Bloomberg

0

1

2

3

4

5

6

7

2007 2008 2009 2010 2011 2012 2013 2014

Policy interest rates, percent

Eurozone

United Kingdom

United States

Bank of Japan


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Emerging market central bank target rates

23

Source: Bloomberg

0

2

4

6

8

10

12

14

16

2007 2008 2009 2010 2011 2012 2013

Russia

Brazil

India

Policy interest rates, percent

China


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Expansion of balance sheets of major central banks

24

Source: Bloomberg


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Central bank assets vs. GDPs of worlds largesteconomies

25

Sources: Federal Reserve, IMF, December 2013

0

2

4

6

8

10

12

14

16

18

United States China Japan US Federal

Reserve

Germany France United Kingdom European

Central Bank

US$trillion


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Output is still below the pre-crisis level in manymajor countries

26

Sources: Bloomberg, Milken Institute

80

85

90

95

100

105

110

Real GDP (Q1 2008=100)

U.S. Germany Japan U.K. Italy

U.S.

Germany

Japan.

U.K.

Italy


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Inflation may be worryingly low

27

Sources: Datastream, Milken Institute.


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Decline in government bond yields in major advancedcountries

28

Source: Bloomberg

0

1

2

3

4

5

6

1/9/2006 1/9/2007 1/9/2008 1/9/2009 1/9/2010 1/9/2011 1/9/2012 1/9/2013

US Germany UK Japan

10-year Government bond yield (%)


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Equities rally in 2013

29

Equity indices in major countries

Source: Bloomberg

Note: U.S. (S&P 500), Eurozone (German DAX), UK (FTSE 100), Japan (Topix)


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30

Introduction 2



Global Action and Impacts 21Tapering 30


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Bernankes taper talks scared the market

31

Source: Bloomberg


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Summer 201332


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Roadmap to tapering33

Projected monthly pace of Fed asset purchases Projected size of Fed balance sheet

Sources: Federal Reserve JPMorgan

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The Mechanics of Finance: The Federal Reserve with Komal Sri- Kumar