By
The
Inflation Trader
:
On Friday, the long-awaited Jackson Hole speech by Ben Bernanke
finally happened. With bated breath, investors waited for news of
his oration. Unfortunately, most investors don't speak "Fed," so it
was manifestly unclear, or clearly unmanifest, what the Chairman
was necessarily getting at. Some investors seemed to be expecting
him to say "start the choppers, boys, and let's light this
candle."
Well, that's not how Fed Chairmen…or economists…or humans,
except for Nicolas Cage…speak. But what Bernanke actually said is
still fairly clear to those who have listened to Fedspeak for a
long time. An important part of Fedspeak is that the speaker
assumes the listener is completely aware of the context, and the
subtext, of his remarks. So let us forget our predispositions for
the moment, about what the FOMC may decide next month, and
dispassionately analyze the arguments currently before the
Committee - which constitute the context in which the Chairman
delivered his remarks.
The doves, when given the floor at the meeting in mid-September,
will say that growth remains unacceptably slow, and that whether
the Fed would like to or not, they are not
permitted
to ignore one leg of their dual mandate. They will observe that
year-on-year core PCE for July was just announced at 1.6%, below
expectations of 1.7% and well below the March high of 2.0%, which
also happens to be the Fed's target. Although this is likely a
temporary phenomenon, the doves will argue that it doesn't matter
if it is; what it means is that they have at least 3-6 months
before core PCE could feasibly be much above their target, and
perhaps 9-12 months before it could be
alarmingly
so. The doves will argue that the tail risks to growth are now
heavily to the downside.
Unmentioned, but a further subtext, will be the recognition that
a Romney Presidency is no worse than a coin flip at this moment,
and the institution might find itself constrained if it should
desire next year to take aggressive action on growth - and if the
party of Romney wins, it is likely to also lead to reduced fiscal
stimulus, or even a fiscal drag. Finally, they will observe that
money supply growth has slowed to only 5.7% on a 52-week rate of
change basis, and even corporate credit growth may be slowing (up
5.4% y/y, but only 3% over the last quarter), so that any easing
action would be adding fuel to a low fire, not to a roaring
blaze.
What is the hawks' rejoinder, when it is their turn?
The economy is sputtering, but it isn't actually contracting.
Housing prices, which had been the economy's albatross, seem to
have turned higher and inventory is clearing. Previous aggressive
monetary policy has not produced very much other than lofty asset
prices, and has skewed markets; moreover, there remains a wall of
money out there that threatens large future costs and small future
benefits.
The best arguments that the hawks seem to have, at the moment,
is that there are large costs to future action and few benefits to
be gained. They can't win on current inflation - it is too low.
They can't win on current growth - it is too low. They are unlikely
to win on asset prices that aren't affecting consumer inflation,
and that many investors don't see as 'bubbly.' They can't win on
the 'balance of global growth risks.' They can't very well argue
that fiscal policy should do more when the balance of power in the
Executive and Legislative branches is up in the air.
The only potentially winning avenue they have is if they can
argue that it isn't worth the risk to add more money, even though
adding lots of money to date hasn't produced runaway
inflation.
To this end, William White at the Dallas Federal Reserve
[1]
(where President Fisher is generally to the hawkish side of the
ledger) recently posted a white paper entitled "
Ultra Easy Monetary Policy and the Law of
Unintended Consequences
," which specifically argues that the long-term costs outweigh the
short-term benefits of 'ultra easy monetary policy.' (
Note: White is also the chairman of the Economic Development
and Review Committee of the OECD and was recently the head of the
Monetary and Economic Department at the BIS, so he's no hack.)
Now, with this context, let's look at Bernanke's speech.
Bernanke is not unaware of White's paper, and he is aware that
everyone else in the roomful of economists is aware of White's
paper. He is aware that the hawks rely on this argument, and he
cannot leave the topic unaddressed.
So Bernanke includes in his speech a section entitled "Making
Policy with Nontraditional Tools: A Cost-Benefit Framework." In it
he declares that "the FOMC carefully compares the expected benefits
and costs of proposed policy actions," but adds forcefully that
"The possible benefits of an action, however, must be considered
alongside its potential costs." He then describes the potential
costs, as he sees them, of large-scale asset purchases (LSAPs). (It
is interesting, as an aside, that he focuses on this one possible
policy action.) And he ultimately argues that - and this is the key
phrase in the whole speech, as far as I am concerned, given the
context and subtext:
"The costs of nontraditional policies, when considered
carefully, appear manageable, implying that we should not
rule out the further use of such policies if economic
conditions warrant."
Thus, Dr. White, you are duly answered. We thought about it, and
the costs are manageable. Thanks for writing.
Having dismissed that argument, Bernanke sets up the doves'
arguments. Not surprisingly, they are the same as the arguments
presented at the August FOMC meeting, which surprised many
observers when the minutes were recently released. The Chairman
said, predictably, that "Unless the economy begins to grow more
quickly than it has recently, the unemployment rate is likely to
remain far above levels consistent with maximum employment for some
time." And he concluded with "the Federal Reserve will provide
additional policy accommodation as needed to promote a stronger
economic recovery and sustained improvement in labor market
conditions in a context of price stability."
None of this means that the Fed will ease for certain, and I am
on record as saying that I think they
shouldn't
but
will.
Bernanke's speech strongly suggests to me that they will do
something,
and since the list of meaningful somethings is very short at the
moment, it will likely be one of three things.
- LSAP of some kind, perhaps in mortgages instead of or in
addition to Treasuries.
- Lowering of IOER - less likely, although smarter. It's also
possible they could
nudge
IOER lower just slightly, as was recently suggested.
- Changing the formulation of the 'extended low rates' promise,
so that it is no longer a date but rather a hard formulation of
the Evans Rule
that has been in place in a 'soft' form since
June
.
I don't think that just extending the 'end date' for the low
rates pledge is a viable option. First, it would disappoint
investors, who are expecting something more concrete from the Fed,
and thus wouldn't have the intended effect anyway. Second, many Fed
officials have grown uncomfortable with the box they have put
themselves in with a hard date that may or may not coincidentally
line up with the evolution of economic variables. Third, most
investors recognize it's not a promise anyway, so it has little
value.
I believe the Chairman has made clear (or as clear as he is
likely to make it in a speech to economists) that more QE is
coming, and if I had to order the three options above I would say
(1) is most likely, (3) is next-most-likely, and (2) is least
likely. Indeed, I think that since the Committee will likely not
want to move at the
next
meeting, which will be quite close to the election, I think there's
a chance they could do some of all three of these.
See also
Gold Stocks Aim Higher In Relation To The Broad
Stock Market
on seekingalpha.com