Up and Down Wall Street
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FRIDAY, AUGUST 31, 2012
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Bernanke Stays on Script, Repeats Fed is Ready to Act
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By RANDALL W. FORSYTH
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Weak jobs data could let FOMC clear "hurdle" for QE3, but don't ignore politics and gold's message.
Say this much for him, Ben Bernanke is no Clint Eastwood.
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The Federal Reserve chairman stuck to his script that monetary policy has worked even with interest rates nailed to the zero-percent floor; that more measures may need to be taken to get unemployment lower; and what's keeping those measures from fully working their magic are things the central bank has no control, such as fiscal policy, the European crisis and the aftermath of the housing crash.
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In his long-awaited speech to the Fed's annual policy confab in Jackson Hole, Wyo., Bernanke broke little new ground but underlined what already came out of the Federal Open Market Committee's August meeting minutes plus various other subsequent nods and winks from Fed officials. Specifically, that further measures, including a third round of quantitative easing (QE3), would be applied as needed.
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That global equity markets rallied Friday is more a reflection that the European Central Bank is thought to be moving closer to wholesale bond buying than the Fed's pledge to act, which already was known. But that gold was the biggest winner should send a warning about the efficacy of more Fed ease.
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In essence, Bernanke argued the Fed's prescription saved the patient but further applications are needed. Critics of the U.S. central bank's policy counter that, while the Fed's initial, forceful initial round of quantitative easing in 2009 was necessary and arrested the economy's and financial markets' frightening downward spiral, subsequent measures have been less beneficial and have entailed significant costs. That, in a nutshell, frames the debate on Fed policy.
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For his defense, Bernanke cited academic studies that concluded the Fed's bond buying -- which he calls LSAP (for large-scale asset purchases) instead of QE -- has had demonstrable positive impacts. Those studies found QE1 in 2009-10 lowered the 10-year Treasury note yield by between 40 and 110 basis points (0.4-1.1 percentage points) while QE2, which started in late 2010, lower the benchmark 10-year yield by 15-45 basis points.
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Adding in the Fed's Maturity Extension Program, aka Operation Twist, underway current, three studies concluded these unconventional measures lowered the Treasury 10-year yield by 80-120 basis points. Obviously, economics is not a science that permits controlled experiments to test the effectiveness of measures, and Bernanke admits the counterfactual of no action can't be verified.
Implicit in Bernanke's arguments for past unconventional policies such as QE is that, even if they haven't been completely successful, more are needed. Unemployment has fallen from a peak of 10% in October 2009 to just over 8% currently -- still far above any notion of full employment. And the Fed chairman has zeroed in on unemployment as the key risk to the economy -- especially long-term joblessness of six months and more, which results in the wasting away of skills needed to find new jobs.
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But, with long-term borrowing costs already at historic lows, how much more would a drop of a couple dozen more basis points accomplish? Lower corporate bond yields have allowed companies to issue a record volume of debt globally this month, some $238 billion, topping the old mark set in August 2010, according to Bloomberg News. But it's not clear that cheap financing is boosting corporations' investment and expansion that create jobs; much of the benefit has been to refund higher-cost debt and return capital to shareholders as dividends and share buybacks.
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Bernanke acknowledged the risks of additional LSAPs in their distorting effects on the capital markets, the Fed's ability to reverse course when tightening becomes needed, and the inducement to excessive risk-taking. Moreover, the Fed could incur losses on its burgeoning bond portfolio when yields do rise. For these reason, he allowed the "hurdle" for unconventional policies is set higher. A weak August employment report, due out next Friday, might allow the FOMC to clear that hurdle at its next meeting, which winds up Sept. 13.
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The potential costs are offset by the need to try to lower unemployment -- even though fiscal policy, financial instability (in large part because of Europe) and the housing overhang remain impediments.
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In his conclusion, Bernanke said, "Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in the context of price stability." This last phrase is taken word-for-word from the Aug. 1 FOMC statement, JP Morgan economist Michael Feroli perceptively points out.
But, as Bill Gross, Pimco's founder, co-chief investment officer and Barron's Roundtable member tweeted after Bernanke's speech, QE3 with open-ended purchases are a near certainty, which he pointedly added will be increasingly "impotent." But gold rallied to the highest level since mid-April, surging $29 to $1686 an ounce, indicating the power the Fed has to lift prices, if not create jobs.
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Indeed, the Fed's QE2 and Operation Twist have had more potent effects on the securities markets and other asset prices than the real economy. Growth continues to slog along at barely 2% and the jobless rate is stuck above 8% with Americans' real incomes declining.
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Bernanke, along with his "dovish" allies on the Fed, including Janet Yellen, the vice chair, William Dudley, the New York Fed president plus his counterparts in Boston, Chicago and San Francisco, appear to favor further action to spur the economy. Hawks, led by Dallas Fed President Richard Fisher (whose bank pointedly and provocatively published a critique of "ultra accommodative" monetary policy this week, as I previously discussed say the marginal and uncertain benefits of a further, slight drop in interest rates aren't worth the costs.
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And the elections loom large. Republican presidential nominee Mitt Romney has declared he wouldn't reappoint Bernanke as Fed chairman when his term is up in early 2014 because of his ultra-easy policies. A Fed easing move in a couple of weeks would widely be seen as a benefit to the incumbent, Barack Obama, who reappointed Bernanke to a second term in 2009 -- many months before his first term ended.
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The Fed tries to appear apolitical, so the most diplomatic decision may be to hold off until the December FOMC meeting. Of course, a financial crisis emanating from Europe would give an unqualified justification for the U.S. central bank to act; indeed, it may want to keep its powder for such a possibility.
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In essence, Bernanke told us the Fed is ready to act again, if needed, and despite the critics of more money printing. We knew that already. At least now we can enjoy the holiday weekend.
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