Bernanke: The Only Game In Town
It is becoming much more apparent that, as we have seen each year for the past three, the Fed's prediction of stronger economic growth by the end of 2013 will be revised lower from the current level of 2.5%. This is due to the continued negative annualized trends in the data which continue to deteriorate despite the Fed's ongoing monetary interventions. The economic data, since the beginning of this year, have continued to point to slower economic growth.
The chart below shows the quarterly change in industrial production at an annualized rate. While not at recessionary levels currently - it is clear that industrial production has peaked for the current economic cycle is now on a decline. Historically, when industrial production has fallen below 0% growth the economy has been near, or in, a recession.
With corporate earnings deteriorating, energy and gas prices rising and unemployment still at very elevated levels the bullish case for equities remains solely supported by the Fed's ongoing interventions.
The recent spike in inflationary pressures, which is almost entirely due to the surge in energy costs, also negatively impacts the economy. The chart below shows the composite inflation index (an average of PPI and CPI) as it relates to economic growth. The spike in inflationary pressures in 2011 coincided with the peak in economic activity. Falling inflationary pressures, as shown, suggests a much weaker economic environment than is currently being reported.
I would not be surprised to see rather substantial negative revisions to current GDP levels in the next year or so. One of the reasons that I think GDP is being over-inflated is due to the retail sales data and the abnormal adjustments to the reports. Bill King, editor of the King Report, also touched on this topic recently stating:
"The soft June retail sales report induced several Wall Street firms to lower their Q2 GDP estimates.
Retail Sales used to correlate exactly to Nominal GDP. Since the Great Crisis the correlation is looser.
Retail Sales vs. Nominal GDP – The probable over-stating of GDP has changed the correlation."
The problem, of course, is that if the only thing supporting the bullish case for equities is the Fed's "bond buying" program; then Bernanke is caught in a very difficult position. This week Bernanke will go to Capitol Hill for his annual Humphrey-Hawkins testimony where the markets will be parsing every word looking for signs of the Fed's intention to reduce monetary support. After the Fed's colossal failure with their recent attempt at "taper-talk," which sent stocks and confidence dropping and interest rates spiking, it is highly likely that Bernanke will be very guarded in his testimony.
Back to Bill King:
"Bernanke and many other advocates of QE have a big problem. They are now trying to convince people that tapering or halting QE is separate from rate hikes. For years they asserted that once ZIRP is employed further rates cuts can be administered via QE because the asset monetization generate benefits similar to those that would accrue from negative interest rates.
In fact numerous Fed officials prepared the market for QE by insisting that X amount of QE would be the same as a Y interest rate cut. Now Bernanke and his ilk are trying to convince the market that QE tapering isn't the same as rate hikes. This contradicts their earlier assertions and modeling.
Indeed, in a Congressional hearing on February 9, 2011, Representative Tim Huelskamp questioned how the Fed 'picked $600 billion' when the FOMC decided on a second round of QE (called QE2) at its November 2010 meeting. Fed Chairman Ben Bernanke responded, 'We asked the hypothetical question, if we could lower the federal funds rate, how far—how much would we lower it?' He noted that 'a powerful monetary policy action in normal times would be about a 75 basis point cut in the federal funds rate. We estimate that the impact on the whole structure of interest rates from $600 billion is roughly equivalent to a 75 basis point cut.'"
So, either Bernanke was lying back then or is he lying now? The problem is that the Fed is literally caught in a "liquidity trap" from which there is currently no escape. If they reduce liquidity the markets tank, taking down consumer confidence and negatively impacting the economy. If they keep the liquidity going they will inflate an asset bubble which will ultimately burst destroying the financial markets and the economy. The choice is, ultimately, a lose-lose scenario even as the bullish case for equities persists.
Of course, as Chuck Schumer stated to Bernanke at the last Humphrey-Hawkins testimony, "You are the only game in town."