The Incredible Lightness Of "Hope"
“Anyone whose goal is 'something higher' must expect someday to suffer vertigo. What is vertigo? Fear of falling? No, Vertigo is something other than fear of falling. It is the voice of the emptiness below us which tempts and lures us, it is the desire to fall, against which, terrified, we defend ourselves.”
This morning the markets fell sharply after Ben Bernanke, as we have repeatedly stated (see here and here), failed to provide more monetary support for the markets through quantitative easing. The emptiness that was carried in Bernanke's speech immediately fueled the media to go on the defensive publishing words of "hope" that Bernanke was clearly suggesting that he would act at the next FOMC meeting. Of course, this was not the case but it has been this "hope" that the markets has carried the markets over the past two months - yet no more action has come.
As we stated recently: "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."
While the markets were initially disappointed it did not last long. The media quickly took selective pieces of the speech as evidence that while Bernanke may have again failed to deliver further accomodative policy - it was clearly a "promise" that more would come in September. To wit - this headline from the WSJ appeared moments after Bernanke's speech: "Bernanke Signals Willingness To Do More."
Of course, this was also the same headline that we have seen post the last two Fed meetings where further action has not occurred. The reality is that Bernanke promised nothing, and certainly made no representations, that anything was coming at the next meeting in September. From Bernanke's speech: "Taking due account of the uncertainties and limits of its policy tools, 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."
That statement has been in every Fed release over the past year. However, the media, and the markets, read into this statement what they wanted to believe. The reality is that with recent economic reports showing mild improvements, the markets near their highs of the year, and interest rates near their historic lows, there is really no need for further QE at this time. Therefore, all Ben could do is exactly what we said that he would do: "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."
While the markets were initially disappointed it played out exactly as we stated: "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."
In moments from the conclusion of Bernanke's speech the media was flooded with headlines and statements that the clues were evident that stimulus was on its way. No not really. Furthermore, what was overlooked was probably the single most important statement made by Bernanke today from Jackson Hole: "A second potential cost of additional securities purchases is that substantial further expansions of the balance sheet could reduce public confidence in the Fed's ability to exit smoothly from its accommodative policies at the appropriate time. Even if unjustified, such a reduction in confidence might increase the risk of a costly unanchoring of inflation expectations, leading in turn to financial and economic instability." This is the first time that we can recall where Bernanke, which is already on record of discussing the diminishing rates of return from previous balance sheet expansion programs, now discusses the potential effects of when balance sheet expansion programs go to excess.
The reality is that there is a limited universe of bonds that the Fed can buy as he stated: "As I noted, the Federal Reserve is limited by law mainly to the purchase of Treasury and agency securities; the supply of those securities is large but finite, and not all of the supply is actively traded. Conceivably, if the Federal Reserve became too dominant a buyer in certain segments of these markets, trading among private agents could dry up, degrading liquidity and price discovery. As the global financial system depends on deep and liquid markets for U.S. Treasury securities, significant impairment of those markets would be costly, and, in particular, could impede the transmission of monetary policy."
The use of a balance sheet expansion programs, while great for the financial markets, cripples the consumer from higher inflationary pressures and has a negative impact on end demand. While the previous programs have been effective at dragging forward future consumption - it has not fostered strong employment growth because end demand has remained weak. The biggest concerns by small business has been "poor sales" not "lack of quantiative easing."
Furthermore, QE programs in the past have caused interest rates to rise, as money moved from bonds into stocks, which will have an immediate and negative effect on the housing market and suppress credit activity. The impact from rising rates will also affect the Fed is also significant as he stated: "the Federal Reserve could incur financial losses should interest rates rise to an unexpected extent."