Bernanke, stick or twist?
All eyes will be on the US Federal Reserve chairman today as he decides whether the world's biggest economy needs more QE
Friday 31 August 2012
At three o'clock today, a hush will fall in dealing rooms across the globe to hang on the every word of the world's most powerful central banker, US Federal Reserve Chairman Ben Bernanke. What they want to know is simple: will he or won't he?
After two rounds of money-printing totalling $2.3trn (£1.45trn) to drag the US economy out of recession, every word of Mr Bernanke's speech at the annual Jackson Hole symposium – "Monetary Policy Since The Crisis" – will be pored over to divine whether "Helicopter Ben" is ready to launch a third burst of quantitative easing (QE).
The chairman – who earned his nickname years ago with an approving reference to arch-monetarist Milton Friedman's suggesion of dropping money out of a helicopter to ward off deflation – has some previous in signalling major policy shifts under the imposing shadow of the Wyoming mountains. Exactly two years ago he trailed the Fed's second $600bn tranche of QE, which ran until June last year.
Whether he will again this time around is splitting opinion but – on the evidence of a particularly soporific August for trading – few players in financial markets are willing to take any chances until they get an insight into the chairman's thinking.
In the US, the Dow Jones Industrial Average has crept to four-year highs, but trading volumes are at historic lows. With prospects for the dollar over the next few months resting on whether Mr Bernanke will decide to conjure billions more out of thin air, analysts also say that currency dealing in euro/dollar markets is down 25 per cent on last year.
Only the hedge funds have been willing to stick their necks out, doubling up long bets on oil prices in hopes that further stimulus will trigger the same, six-month rally in crude seen after QE2 two years ago.
Mr Bernanke has the stage to himself as European Central Bank president Mario Draghi stays away to finalise details of the ECB's bond-buying plan to ease debt woes in the eurozone. The International Monetary Fund's managing director Christine Lagarde is also absent.
While the Fed chairman may give himself leeway on QE3 until he has looked at Mr Draghi's lifeboat, the US economy's downbeat prospects are likely to dominate his thinking.Minutes of the last rate-setting meeting published last week set the hares running as they underlined the doves holding sway on the Federal Open Markets Committee (FOMC). Many members thought "additional monetary accommodation would likely be warranted fairly soon" unless there was a "substantial and sustainable" strengthening in the recovery.
The Fed has already signalled that interest rates will remain at between 0 per cent and 0.25 per cent until 2014 at the earliest. And despite better news from US industry, the housing market and consumers in the past two weeks – and stronger than expected annualised growth of 1.7 per cent between April and June – the unemployment rate is up again to 8.3 per cent.
The Fed believes that the economy needs to be growing by 2-2.5 per cent a year to make consistent inroads into dole queues.
On top of this, forward-looking indicators are flashing up warning signs.Petrol prices are up 40 cents a gallon in the past five weeks, which feeds through to consumer wallets far more quickly in the US due to its much lower fuel-duty regime.
Both the University of Michigan and the Conference Board measures of consumer sentiment point to a worrying slowdown in spending and a growing pessimism among US households.
Then there's the "fiscal cliff". Because of the failure of the Congressional bi-partisan "super committee" to agree cuts last year, automatic cuts are looming which could knock some 3.5 per cent – or $500bn - off the world's biggest economy next year. Although some degree of negotiation looks likely after November's presidential election to avert the worst-case scenario, it's hard to see the US economy taking a great leap forward early next year.
James Knightley, an economist at ING Bank, said: "The minutes were reasonably clear that they would rather do something than not. They have a dual mandate for full employment as well as price stability. At the moment inflation is at 2.1 per cent and is no barrier to action."
Others believe that Mr Bernanke could hedge his bets slightly, stopping short of full-blown QE3 but instead signalling that interest rates will stay where they are into 2015, or hinting at an extension of the current, so-called "Operation Twist". This doesn't involve printing money but instead the Fed sells short-dated bonds and buys long-term debt with the purpose of bringing down long-term interest rates and boosting growth.
The Fed chairman is unlikely to offer an explicit endorsement of QE3 one way or the other ahead of the FOMC's next meeting on 13 September, although – as with so much of central banker communications – it's the reading of the tea leaves that matters. A detailed discussion of the easing options available to rate-setters by Mr Bernanke, for example, is likely to be taken as a signal that the committee is ready to move sooner rather than later.
Certainly some form of help for the economy looks likely later this year, whatever form it takes.
Mr Knightley adds: "Market expectations have risen. The Fed doesn't like to disappoint them."
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