QE3 Mechanism Is Broken
When Ben Bernanke launched QE 2 in 2010 he outlined a third mandate for the Federal Reserve - the boosting of consumer confidence. He stated that the goal of QE 2 was to boost asset prices in order to spur consumer confidence through the "wealth effect" which should translate into economic growth. In 2010 he was right, and QE 2 not only boosted asset prices sharply, but kept the economy from slipping into a recessionary spat. As Friday's speech from the economic summit in "Jackson Hole" draws near - Bernanke should be taking a clue from today's release of consumer confidence in considering his next move.
The Conference Board released today a report on consumer confidence that was more than just disappointing. Not only did the consumer confidence index come in at the lowest level since 2011, when the government was last struggling with debt crisis and U.S. ratings downgrade, but the future expectations of the economy plunged 8 full points from 78.4 in July to 70.5. The three components on future business conditions, employment, and income all deteriorated sharply showing a consumer struggling to make ends meet. This pessimism, particularly in incomes, poses a risk for retailers going forward and suggests weaker GDP data ahead.
It is not just the Conference Board's consumer confidence index that is showing deterioration as of late. In a recent post we showed the Rasmussen and Bloomberg polls as well. The story is the same with confidence sliding markedly in recent months. I have taken that analysis one step further and have created a composite index consisting of the Conference Board Consumer Confidence and Expectations indicies, Bloomberg Consumer Comfort Index, Rasmussen Consumer Index, University of Michigan Consumer Confidence Index and the State Street Investor Confidence Index. By combining the varied confidence indexes into a single composite - this should give us greater insight into the trends of overall sentiment.
The Consumer Confidence Composite, shown below, declined in August to 72.15 from 76.27 in July. Furthermore, the index deteriorated from its 2012 peak of 79.3 in May. While the overall index remains above the August 2011 lows of 59.9 the trend has turned decidedly negative.
What Does This Have To Do With Bernanke?
Well, just about everything actually. Take a look at the chart below that compares the consumer confidence composite index with the S&P 500. You will notice that historically there is a fairly high correlation between asset prices and consumer confidence. You can see the bump to consumer confidence as asset prices have risen in the past. Therein also lies the problem for Bernanke on Friday.
Over the past couple of months asset prices have risen markedly and are now poised near the highest levels of year. In the meantime, consumer confidence has continued to deteriorate, especially in forward expectations, which shows a divergence that has typically signified weaker markets in the future.
The problem is that for Bernanke it appears that the transmission mechanism between asset price increases and consumer confidence may be broken. When Bernanke has implemented balance sheet expansion programs in the past it has been done after asset prices had already taken meaningful hits - not when they are closing in on highs of the year. What Bernanke is potentially facing is that while an additional QE program might temporarily, and modestly, boost asset prices from current levels it will not necessarily promote consumer confidence leading to an economic lift. In other words, there could well be a negative return from QE at current levels which is consistent with Bernanke's concerns of diminishing rates of return from each of the previous programs.
Bernanke has consistently asked Congress for help from fiscal policy but to no avail. The downturn in consumer confidence, in the face of rising asset prices, indicates that consumers may be hitting the wall. Consumer credit has surged back to pre-recession peaks, not for the purposes of acquiring more "stuff" which would translate into higher levels of economic growth, but rather just to maintain the current standard of living. So, while Wall Street begs for more stimulus to boost asset prices, and their bonuses, the rest of America appears to be struggling with the effects of the stagnant wages, rising commodity costs, and high unemployment combined with concerns about the fiscal cliff, the impact of ObamaCare, and the future of the economy given rising debts and deficits.
If Bernanke is paying attention it is likely that this Friday will come, and go, without the implementation of QE 3. More likely we will see the continuation of the ultra-low interest rate policy with a possible extension beyond 2015 and the continuation of the statement that the Fed stands ready with accomodative action if necessary. In other words, come Friday, it is likely that market participants will be disappointed.
Of course, for the "stimulus addicted junkies" on Wall Street, a disappointment on Friday will only embolden them to believe that the next "hit" will come in September. Of course, that has been the same "disappointment/hope" cycle we have witnessed play out over the last few months. Do not misunderstand me as I do think that QE-3, 4, 5...20 is coming - it will just be when markets are pricing in an economic or systemic event of greater proportions. The cycle of boom and bust is going to be with us as long as the only policy tools considered by the Central Banks is the use of debt to resolve a debt bubble. It will eventually fail as 800 years of history have repeatedly proven - the only question will be which Central Bank will be left holding all the debt when it happens?