Jackson Hole Bankers Reflect on QE2

Fed's Bernanke under pressure to undertake additional steps to aid economy.

Chairman Ben S. Bernanke has big shoes to fill this week when he speaks at the Federal Reserve’s annual symposium in Jackson Hole, Wyoming: His own.

Last year, Bernanke hinted that the Fed might embark on a second round of asset purchases to bolster the recovery, kicking off a 28 percent rally in the Standard & Poor’s 500 Index of stocks that ended in a three-year high on April 29.

Now, any boost to the economy from the Fed’s $600 billion of bond buying is hard to detect, with growth slowing to a less- than-1-percent annual pace in the first half, the U.S. losing its top credit rating from S&P and stocks falling about 18 percent from their peak.

The deterioration -- coupled with a government that’s cutting spending and showed itself to be “dysfunctional” ahead of the debt-ceiling expiration this month -- increases the pressure on the U.S. central bank to show it can and will help expansion, according to Neal Soss, chief economist at Credit Suisse Holdings USA Inc.

Policy makers this month pledged to keep their benchmark interest rate near zero until at least mid-2013 and also said they “discussed the range of policy tools” available, signaling they may add to their record stimulus.

Bernanke will be making “a major speech and the chairman knows the whole world is watching, so if he chooses not to say very much, the markets and the economy in some broader sense would be disappointed,” said Soss, a former economist at the Federal Reserve Bank of New York. “It’s absolutely critical that the Federal Reserve portray itself as having some relevance to the economic problems the society faces.”


Record Lows
Soss predicts Bernanke will suggest that the central bank plans to lengthen the average maturity for its $2.86 trillion of assets, which would help bring down long-term interest rates. The yield on the benchmark 10-year Treasury note was 2.062 percent at 5:14 p.m. on Aug. 19 in New York, according to Bloomberg Bond Trader prices. Yields have fallen to record lows since the Fed announced its rate pledge on Aug. 9.

Bernanke’s decision about whether to expand his unprecedented monetary easing comes as he faces the most internal opposition in his five-year tenure, and after his earlier measures sparked criticism. The latest bond-purchase program ignited the harshest political backlash against the central bank in three decades, with Republican lawmakers saying the policy risked causing a surge in inflation.


Rare Dissent
Federal Reserve Bank presidents Charles Plosser of Philadelphia, Richard Fisher of Dallas and Narayana Kocherlakota of Minneapolis all voted against the Fed’s decision to keep the target for the federal funds rate at zero to 0.25 percent until at least mid-2013. Plosser and Fisher both said last week the pledge won’t help spur growth. The last time three policy makers dissented was in November 1992.

“Our problems are not problems easily addressed by monetary policy,” Plosser said in an Aug. 17 interview, adding that the Fed is “risking its credibility because it’s doing things that don’t work.”

It isn’t clear how much any additional actions would help, given the Fed has already exhausted many of its tools, said Nigel Gault, chief U.S. economist at IHS Global Insight in Lexington, Massachusetts. The central bank has kept the rate on overnight loans among banks near zero since December 2008. It also purchased $1.7 trillion of Treasury and mortgage debt between December 2008 and March 2010, and the $600 billion of Treasuries from November through June.


No Rabbits
“Unfortunately, the Fed doesn’t have any rabbits to pull out of the hat to magically reignite economic growth,” Gault said. “It is doing what it can, and despite the dissent, that will probably mean a QE3 program at some point, but its prime ammunition has already been used.”

Bernanke told Congress on July 13 the Fed does have stimulus options; these include buying additional securities, increasing the average maturity of its bond portfolio, lowering the interest rate on excess reserves and pledging to keep its balance sheet near a record high for a longer period of time.

He also foreshadowed the Federal Open Market Committee’s Aug. 9 decision to hold interest rates near record lows. The S&P 500 Index climbed 7.6 percent between Aug. 8 and Aug. 15, and has since fallen 6.7 percent amid concerns that U.S and global economic growth are faltering.

“The Fed got a pretty good response” to its decision, “so I think he’ll try to continue to play his cards in a measured fashion,” said Ward McCarthy, chief financial economist at Jefferies & Co. in New York, who also predicts the Fed will increase the average maturity of its portfolio. “We’ll see something similar to last year.”


May Be Disappointed
The bond market already is pricing in an expectation that the Fed will announce new purchases of $500 billion to $600 billion, Barclays Capital analyst Anshul Pradhan said in an Aug. 12 report. Investors looking for confirmation in Bernanke’s Jackson Hole speech may be disappointed, he said.

While it’s difficult to evaluate whether the last round of asset purchases, or so-called quantitative easing, helped the recovery, the program “has to get a high grade” for raising inflation expectations and diminishing deflation concerns, McCarthy said.

The cost of living in the U.S. accelerated at an annual pace of 1.8 percent in July, excluding food and energy costs, which are typically more volatile. The gain was the largest in more than a year, according to Labor Department data released Aug. 18.


Stalling Expansion
The breakeven rate for five-year Treasury Inflation Protected Securities, the yield difference between the inflation-linked debt and comparable maturity Treasuries, was 1.67 percentage points on Aug. 19, up from 1.13 points on Aug. 24, 2010. The rate, a measure of the outlook for consumer prices over the life of the securities, has fallen from 2.47 percentage points April 29 on concerns that the expansion is stalling.

The economy grew at a weaker-than-projected 1.3 percent annual pace in the second quarter, the Commerce Department said July 29. Growth in the prior quarter slowed to 0.4 percent, the weakest three-month period since the recovery began June 2009.

JPMorgan Chase & Co. reduced its estimate for fourth quarter expansion to 1 percent from the 2.5 percent it previously predicted and lowered its first quarter 2012 forecast to 0.5 percent from 1.5 percent, Michael Feroli, JPMorgan’s chief U.S. economist in New York, said in an e-mailed note to clients on Aug. 19.


‘Elevated’ Risks
Consumer sentiment is falling and the housing market has failed to gain momentum, he said. Global growth also “has disappointed and foreign-growth forecasts have been taken lower,” he added. “Risks of a recession are clearly elevated.”

Morgan Stanley analysts have cut their estimate for expansion worldwide this year to 3.9 percent from a previous prediction of 4.2 percent. Part of the reason was “the drama” around lifting the U.S. debt ceiling, which helped depress financial markets and erode business and consumer confidence, the analysts said in a report last week.

President Barack Obama signed a plan to raise the federal debt limit on Aug. 2, the deadline to avoid a possible default, after months of wrangling with Congress. The deal would make $2.4 trillion in deficit cuts over 10 years.

Any new easing by the Fed likely would expose the central bank to further criticism. Texas Governor Rick Perry, who this month announced his bid for the 2012 Republican presidential nomination, caused an uproar on Aug. 15 with a comment about Bernanke increasing monetary stimulus before November next year.

'Treasonous’ Behavior
“If this guy prints more money between now and the election, I don’t know what you would do with him,” Perry said in Cedar Rapids, Iowa. “We would treat him pretty ugly down in Texas. Printing more money to play politics at this particular time in American history is almost treacherous -- or treasonous -- in my opinion.”

Bernanke also would have to overcome internal opposition to additional measures after his rate pledge led to the three dissents. There is less agreement this year among FOMC members that further easing is needed than there was a year ago when Bernanke spoke out, said John Silvia, chief economist at Wells Fargo Securities LLC in Charlotte, North Carolina. That’s one reason he predicts the Fed chairman won’t hint at additional measures in Jackson Hole.

“I kind of doubt there will be anything big and spectacular announced,” Silvia said. “I don’t think it’s the right thing to do as a leader because you’re disenfranchising the people who dissented.”

Still, Bernanke’s decision to pursue the rate pledge signaled he may expand record monetary stimulus, with or without the full support of his fellow policy makers.

“He is a man on a mission and that mission is to try to get this economy back on a more normalized growth trajectory,” McCarthy said. “They already made their feelings felt and I don’t think that will stop him.”

Bloomberg News


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