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A signal from the Fed?
Posted on 18-08-2011 | 0 comments
In the midst of global financial market turmoil and following the downgrade of its government’s credit rating in the previous week, the US Federal Reserve Bank announced on August 9th that it anticipated that the dismal state of the domestic economy and developed world growth prospects would “warrant exceptionally low levels for the federal funds rate at least through mid 2013”. What does this mean for projection of US interest rates? In particular, is there a case for narrowing the distribution of projected possibilities for US short rates over the next two years in line with the Fed’s anticipated path?
When thinking about the probability that should be attached to the Fed’s scenario, it is worth saying that there are many other scenarios that could play out over the coming years. Whilst central bankers are clearly smart people, even they would not claim to have perfect foresight. Past attempts by economists to forecast financial and economic circumstances have been fairly unsuccessful and are naturally constrained by the practical challenge of forecasting the behavior of a complex, dynamic social system which we do not (and probably never will) fully understand. In other words, I think we should be sceptical of any forecast. Uncertainty about what will and can happen to asset prices is one of the reasons that stochastic models can offer significant insights. There is little doubt that, with S&P’s credit downgrade of the US and the intensification of the Euro area debt crisis, the future of the global economy is especially uncertain and investor confidence is unusually fragile. This leaves policymakers in a weak position when it comes to making rhetorical guarantees or promises.
The announcement by the Fed is best interpreted – by the sceptic – as a fairly clear (and worryingly impotent) attempt to calm the markets as opposed to an unshakeable commitment to a certain monetary policy stance. The clear internal wrangling that was behind the decision (signalled by the split in the vote 7-3) and the fairly slippery language used to make the announcement (“[The Federal Open Market Committee] will continue to assess the economic outlook in the light of incoming information and is prepared to employ these tools as appropriate.”) doesn’t really inspire belief that a low rate environment is something that policymakers will enforce ‘come hell or high water’. If, for example, inflation rates continue to tick up and expectations lose anchor there will be pressure to respond. The question we need to ask is how much attention should we pay to this announcement when thinking about yield curve projections for the coming years? As is so often the case, market instruments offer an important source of information.
How have participants in the market for US treasuries reacted to the announcement?
The falling prices of risky assets and the corresponding flight to safety depressed yields between August 1st and 8th across all maturities. Subsequently, as might be expected, longer yields have not reacted (much) to the Fed statement, although at shorter maturities curves appear to have become slightly more depressed. Whether this will persist remains to be seen.
So, how does the Fed signal feed through to our views on the potential outcomes for yield curves over the coming two years? To the extent that the market would be calmed by the news and to the extent that the market believes the announced rate paths, our calibrations and views should naturally adjust to reflect this (whilst also weighting some longer term fundamental views). From the market reaction so far the implication is that the Fed announcement is being treated with an understandable degree of scepticism by investors.
Stochastic projection methods are implicitly sceptical but don’t provide explicit explanations for the scenarios generated. We can tell stories around some of these scenarios and debate probabilities – Rumsfeld’s known unknowns – for example, the inflation surprise that triggers a response from the Fed. Other scenarios – the unknown unknowns – are more elusive and therefore can, ultimately have a bigger impact on future prices. It is easy to forget this important source of risk.
Barrie & Hibbert in the press: ifaonline, Risk.net, and the Actuary
Posted on 08-07-2011 | 0 comments
How to use Barrie & Hibbert's retirement tool
ifaonline.co.uk
"John Higgins and David Campbell believe the at- retirement space is currently underserved by financial planning tools. Advisers are provided with plenty of options for which tools to use in the accumulation of their pension funds but have little to help decide the most effective approach to managing the transition to retirement and how to optimise their income in retirement."
Comment: Practical considerations are compromising Solvency II methodology
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Pensions: Value at Risk
The Actuary
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