Did someone press the Pause button on the stock market this past week? Perhaps the market was breathlessly awaiting word from the annual Federal Reserve Bank of Kansas City Economic Symposium. The result was very little movement and even less enthusiasm.
Monday, Asian stocks closed mixed, but overall fell over 0.5% on continuing negative news coming out of China. On the other hand, stocks in Europe rode a wave of optimism for no particular reason, closing up about 1%. Monday was a non-event in the U.S. stock market on unusually low volume with the exception of APPL making new highs in reaction to a billion dollar patent legal victory over Samsung. Also, the Dallas Federal published a report on the downside of monetary accommodation. Some of these “unintended consequences” are: “malinvestment,” inflation/deflation risk, “financial instability,” “imprudent” borrowing and lending, breaking of markets, encouraging government excess, and a higher-risk central bank balance sheet. Here’s a good summary:
They [ultra easy monetary policies] create malinvestments in the real economy, threaten the health of financial institutions and the functioning of financial markets, constrain the “independent “ pursuit of price stability by central banks, encourage governments to refrain from confronting sovereign debt problems in a timely way, and redistribute income and wealth in a highly regressive fashion.
It’s worth looking over—especially as a counterpoint to Bernanke’s speech Friday.
Tuesday, stocks in Asia again closed mixed but overall flat. Europe gave back most of the previous day’s silly gains. U.S. stocks went nowhere again on unusually low volume. Stocks marked time Wednesday in Asia. Europe gave back the rest of Monday’s gains, losing about 0.4%. U.S. stocks closed flat on continued abysmal volume as the Fed Beige Book reported tepid growth data for the most recent quarter.
Thursday, the dikes holding back the waves of reality started to give way. Asia dropped about 1%. Europe followed, dropping 0.75%. Supposedly, an Italian bond auction went well and softened the decline. Stocks in the U.S. dropped about the same amount, ending at round-number thresholds for the S&P 500 Index and the Dow Jones Industrial Average. The VXO jumped up 6%, adding to the otherwise steady rise for week to close over 17.
Friday, Asian stocks followed the letdown in the West and lost over 0.5%. Another rumor (will they never stop?) that the head of the German central bank will resign, cheered markets in Europe and the U.S. early in the day. European stocks closed up about 0.5%. As the zero-hour approached, U.S. stocks erased the losses of the previous day, but when hope for imminent QE3 was dashed, stocks descended—but only temporarily before they shot upward again—closing up 0.6% on low moderate volume.
Meanwhile, everyone’s darling Facebook, which had been holding the line at $19 per share for a while, broke down sharply to lose another 5% and drifted down to end the week at 18.06. Gold mining stocks shot up around 4%, while the 10-Year U.S. Treasury Bond yield declined 3.5% to 1.56. VXO retreated 5% Friday but despite that big move was still up about 14% for the week to close at 16.32.
At the onset of his 2012 Jackson Hole speech Bernanke set the context of having lowered interest rates to the “lower bound.” The central bank is now constrained to using “nonconventional” monetary policy tools to further effect its mandate. This tends to put to silence those who suggest that the central bank would or should lower rates below zero.
Then, in December 2008, as evidence of a dramatic slowdown mounted, the Committee reduced its target to a range of 0 to 25 basis points, effectively its lower bound. That target range remains in place today.
Notwithstanding these positive signs, the economic situation is obviously far from satisfactory. The unemployment rate remains more than 2 percentage points above what most FOMC participants see as its longer-run normal value, and other indicators–such as the labor force participation rate and the number of people working part time for economic reasons–confirm that labor force utilization remains at very low levels. Further, the rate of improvement in the labor market has been painfully slow. I have noted on other occasions that the declines in unemployment we have seen would likely continue only if economic growth picked up to a rate above its longer-term trend. In fact, growth in recent quarters has been tepid, and so, not surprisingly, we have seen no net improvement in the unemployment rate since January. Unless the economy begins to grow more quickly than it has recently, the unemployment rate is likely to remain far above levels consistent with maximum employment for some time.
As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation. The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.
Over the past five years, the Federal Reserve has acted to support economic growth and foster job creation, and it is important to achieve further progress, particularly in the labor market. 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.
In his conclusion, Bernanke reminds us that in order to pull the trigger on nontraditional policy tools, the FOMC needs a more compelling case.
Consequently, the bar for the use of nontraditional policies is higher than for traditional policies.
What does this all mean? The stock market reacted lower to the speech at the onset, but rebounded quickly after further reflection. Keep in mind, after the 2010 Jackson Hole speech, QE was not announced until November 3rd. Election Day 2010 was November 2nd. That election was simply a congressional election. This year we have a presidential election.
Consequently, it’s reasonable to believe that a QE move before this year’s election is off the table. The Fed, and Bernanke in particular, has taken too much heat already to heap upon itself the accusation of election tampering through monetary policy. This places the September and October meetings in a pseudo “lame duck” status. However, given the intensity of concern stated by Bernanke Friday and the statement (below) from the August 2012 FOMC meeting minutes, I’m inclined at this point to expect more forward guidance to keep interest rates exceptionally low (at the zero bound) into 2015.
Many members expressed support for extending the Committee’s forward guidance, but they agreed to defer a decision on this matter until the September meeting in order to consider such an adjustment in the context of updates to participants’ individual economic projections and the Committee’s further consideration of its policy options.
If the theory holds, that Romney has been selected for the next president, Bernanke knows his days are numbered. Romney has stated he will not reappoint him as chairman of the Federal Reserve. Bernanke will become increasingly obsessed over his legacy. His bosses will not allow him to goose the market before the elections. In fact, I expect them to take it down. However, they likely will allow Bernanke to save face and pretend he’s trying to aid the economy by extending forward guidance in the FOMC statement on September 13, 2012. The caveat would be, if there’s a stock market crash, sufficiently to assure a Romney victory, then his bosses may actually allow the Fed to step in with additional QE before the election.
It should be interesting to watch this drama play out.