Weak economic data has pressured global stock markets for the past four weeks. Investors are growing impatient, clamoring for Fed Chairman Ben Bernanke to unveil additional stimulus measures.
At Ben Bernanke’s last press conference, reporters assumed the voice of investors worldwide in asking in every way possible if the band with the least catchy name in the business (The Federal Open Market Committee) might return for just one more encore. The traditional set list has long been exhausted but even a repeat of the last few songs would be welcomed by increasingly anxious investors. Specifically, investors are collectively begging the Fed to buy even more U.S. government debt, a gig they call quantitative easing. By purchasing massive amounts of government bonds, interest rates are artificially lowered. In the past this has also helped to push asset prices indiscriminately higher, at least temporarily. After four weeks of stock market losses, investors are anxious for a Fed-induced reprieve.
Fed Chairman Bernanke didn’t overtly dismiss the notion when asked, but was careful to differentiate the circumstances surrounding past and future action. He stated that the second act of stimulus (quantitative easing, part two) was justifiable to combat the risk of deflation or falling prices. He suggested that if there was a third round, now commonly referred to as “QE3,” it had the potential to be hazardous as monetary action did not have the ability to selectively raise only stock prices, but commodity prices as well, thus spurring inflation. Furthermore, he reiterated that any need for an encore may be premature in light of the expectation of an improving economy.
The Fed and Wall Street have long been calling for decidedly more robust economic growth in the second half of the year. The public has been strung along through a list of catchy phrases that have all served to underestimate economic weakness. It started with the Fed’s suggestion of a “slow patch,” a phrase largely dismissive of any lasting concerns. That was followed by recognition that “headwinds may be stronger and more persistent.” In the last statement though, the Fed nearly caved. In it the Fed conditionally pledged to keep interest rates low “at least until mid-2013.” While even the hint of such a commitment may be a perceived as beneficial, the realization that such long-term support was apparently necessary raised concerns. Nonetheless, the Fed is reluctant to let go of their forecast for a recovery that has yet to materialize and are hesitant to return to the stage for QE3.
In our estimation the Fed is simply slow to admit that their expectation for a dramatic recovery in the second half of the year is delusional. To their credit it may simply be a rouse in an attempt to instill confidence, but investors banking on the scenario they portray have been largely disappointed.
The “slow patch” has gotten pretty rough and shows no sign of abating. The “headwinds” have been strong enough to push the economy to the brink of recession. Higher stock prices were supposed to have created a “wealth effect” that encouraged higher consumer spending, but that notion appears fleeting at best. Inflation should be the fly in the ointment that prevents further monetary stimulus, but instead I suspect it will be conveniently dismissed as a slower economy has led to lower oil prices and a moderation in the government’s understated inflation gauges.
The stage is thus set for a third encore. As we have written, some Fed committee members are understandably weary of making the trek back to the spotlight, especially if such a trip is perceived as a response to recent stock market turmoil. Thus it may take some cajoling on behalf of the Chairman to get them all on the same sheet of music, but Bernanke appears committed to doing so. If stock prices reflect an economy flirting with recession, Bernanke will walk out to the raucous applause of anxious stock market investors. The appreciative audience will undoubtedly be joined in silent approval of a man on Pennsylvania Avenue fearful of joining the 15 million unemployed Americans next November.
The timing of such an announcement is of particular interest to market speculators. Increasingly, investors hope that Bernanke will tip his hand during a speech in Jackson Hole this Friday, coincidentally the same location he announced the second encore.
The prudent investor is hesitant to adopt the market’s Christmas morning-like giddiness for Friday’s potential announcement. While recognizing a third encore may be well received, enthusiasm should be tempered by a realistic assessment of an economy desperate for assistance and a sobering recognition that previous quantitative easing has done little to alleviate the economy’s fundamental ills.