Markets await Jackson Hole, says Fidelity’s Nick Armet
The question facing Federal Reserve chairman Ben Bernanke ahead of his speech at the Jackson Hole Federal Reserve symposium is whether he does have a magic bullet, says Nick Armet, associate director Investment Communications at Fidelity International.
Expectations are worryingly high. It was in this speech at the same conference last year that Bernanke (pictured) lit the fuse on a rally in risk markets, by announcing his plans for QE2; the second round of quantitative easing. The markets are now clamouring for QE3, or some other magic bullet, but the hard facts of the matter are there are few viable options left available to Bernanke at a time when inflation is considered to be too high to allow aggressive monetary stimulus.
It is ironic that despite the fact QE2 failed to put the US economy on the sustainable growth path that it was designed to, investors are nevertheless hoping for QE3. The market’s desperation for monetary medicine is starting to resemble a patient on a morphine drip. The fact the market cries for more whenever the pain kicks in is not entirely its fault: Bernanke may have set the precedent.
Bernanke has, in fact, admitted to targeting weak stock prices via quantitative easing. This has given rise to the concept of the ‘Bernanke put’ – the feeling in stock markets that Bernanke will act to support market levels when necessary on the basis that higher markets can, via wealth effects, help the real economy.
Some investors believe recent sharp falls in stock markets, in and of themselves, raise the prospect of QE3. It was partly in reaction to market falls that Bernanke announced QE2. Stocks rallied strongly on the announcement and the implementation but have weakened significantly since QE2 ended in June 2011 (see chart). The market seems to be trying its best to force Bernanke’s hand into further action.
We may even have moved into a ‘a bad news is good news’ phase of market behaviour, where each poor data point is interpreted favourably if it makes further QE more likely. After all, unlike European central bankers, part of Bernanke’s remit is to protect and promote economic growth. And the data has been dire: the recent Philly Fed Survey of US business conditions came in at -30 versus a consensus expectation of +2, a reading which is predictive of recession.
But, for all the sense of déjà vu that we are back where we were last summer, things are different now. Then deflation was a serious concern. Now, the key barrier to another round of QE is inflation, which is still relatively high in major economies due to the lagged impact of high commodity prices. It is even more problematic in emerging economies like China, India and Brazil. On the other hand, prices of industrial commodities like oil and base metals could be expected to weaken if the global growth outlook continues to deteriorate. Such a correction in commodities could make another round of quantitative easing more likely.
However, the real problem for many commentators is that QE2 was not ultimately effective in putting US and global growth back on a firm footing, so why do we need QE3? Especially, as many economists now argue, at a time when it might imply more inflationary risks for the world economy without having the desired effect on growth.
The consensus among expert Fed watchers is that we will not get the hoped-for announcement of QE3 on Friday. Bernanke is expected to only clarify the Fed’s current position in terms of its preparedness to use its balance sheet and its commitment to very low interest rates through to 2013. There is also a political interpretation that suggests the Fed might keep its powder dry a little longer given that 2012 is an election year.
A compromise QE2.5 easing strategy is possible where the Fed extends the average maturity of its portfolio, by buying long-dated assets and selling short dated assets. However, with bigger expectations building among investors, the risk remains that “Jackson Hole” disappoints markets this time around.
Perhaps, once investors realise there are no panaceas, magic potions or silver bullets, we might ultimately get less volatility in markets, as it dawns on them that no-one is immediately acquiescing to their tantrums.
Nick Armet is associate director Investment Communications at Fidelity International.