The message out of Ben Bernanke’s Jackson Hole speech: Nothing to see here. Time to move on.
The markets had been clamoring for another round of quantitative easing to give stocks a lift. But Fed chair Bernanke didn’t discuss it, or any of the other blunt tools the central bank has on offer. The Fed “will continue to assess the economic outlook in light of incoming information and is prepared to employ its tools as appropriate to promote a stronger economic recovery in a context of price stability,” he said. Some market-watchers are interpreting that as a sign more Fed help may be on the way. But here are some reasons why that’s just false hope, at least in the near term:
1) A successful Fed speech is meant to be bland, which lends itself to wild imaginations. A good speech “allows investors to read into it what they want, so people pick out portions of it to confirm what they already expected,” says the American Enterprise Institute’s Vincent Reinhart. So despite the frantic over-analyzing of a panicked Wall Street, as New York Magazine put it, “Sometimes a speech is just a speech.”
2) The economy is in different shape than it was last year, though obviously not for the better. The Bureau of Economic Analysis just revised its annualized estimate of second-quarter growth downward to a mere 1%, and the global economy is also contracting. But the first rounds of QE1 and QE2 weren’t just a remedy for growth; they came in response to the threat of deflation. Now, inflation is just below 2%, which is where the Fed wants it, which makes QE3 less applicable. “You have to be aggressive when you’re below your inflation goal. But that doesn’t predict how Bernanke will act when he’s at the inflation goal,” says Reinhart.
3) Bernanke is dealing with a slim governing coalition, and he isn’t likely to get ahead of his committee. There were three dissenters to the Fed’s last announcement to keep interest rates low until mid-2013. Until inflation comes down to a level that would make QE3 justifiable to more Fed board members, don’t expect the policy to suddenly jump onto the scene.
Of course, that doesn’t mean QE3 will never come. The longer unemployment stays high, the more inflation will come under pressure. Under lower inflation conditions, the benefits of another round of QE (higher prices for stocks and corporate bonds, more consumer confidence) might start once again to outweigh the costs (rising commodity prices and political attacks) in the minds of wary Fed board members. As bond fund giant PIMCO’s Mohammed El-Erian noted before Bernanke’s speech:
Compared with August 2010, inflation is higher, structural impediments to job creation are deeper, the global environment is less co-operative, and the independence and credibility of the Fed are under greater pressure. Moreover, judging from the fleeting impact on risk sentiment of last week’s Federal Open Market Committee statement on interest rates, markets seem less sensitive to Fed shock therapy.
All this serves to tilt Mr. Bernanke’s policy equation towards greater costs and risks. Accordingly, rather than embark on another policy initiative (“QE3”) with questionable net benefits, it would be better for Mr. Bernanke to use his Jackson Hole speech to reframe the national policy debate and, in the process, set the state for President Barack Obama’s key economic announcements on September 5.
That’s precisely what Bernanke did and nothing more, whether the markets want to believe it or not.