More Fed QE: done deal or Pavlovian response?

September 12, 2012

“Will he or won’t he?” That’s what investors, traders and policy-watchers in the financial markets are pondering, frozen at their terminals waiting to find out if Federal Reserve Chairman Ben Bernanke will persuade his colleagues to print more money this week.

Among economists who work for primary bond dealers, the firms who sell government bonds directly to the Fed, there’s a striking conviction rate that he will, 68 percent, according to the latest Reuters Poll of probabilities.

The wider forecasting community isn’t far behind, at 65 percent.

While that kind of probability is more than enough to make people paid handsomely to take huge bets with other people’s money to confidently say something is a done deal, the real policy decision is probably a lot closer.

Indeed, just a few weeks ago, after Bernanke gave a speech at the Fed’s annual conference in Jackson Hole, Wyoming that failed to give a clear signal for the timing of more QE or indeed whether or not he would print more money, the broad consensus among economists and global asset managers was a mere 45 percent chance it would do so at the meeting this week.

That’s about as split down the middle as these unscientific debates through analyst polls can go.

Since then, one major bit of economic news was a set of disappointing payrolls data. Jobs growth in August was 96,000, well below the Reuters Poll consensus for 125,000, and below 141,000 in July, although this is from a survey for which a month-on-month change of 100,000 or greater is considered statistically significant.

Also in the interim, the European Central Bank took perhaps the most decisive action yet to prevent the euro zone crisis, which has been the biggest drag on the world economy, from spreading.

That said, the Federal Open Market Committee did make it clear in minutes to their July-August policy meeting that the bar preventing any further action was fairly low:

Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.

Rewind to the autumn of 2010, after Bernanke made what most analysts agree was a much clearer signal at his Jackson Hole speech that the Fed intended to launch a round of bond purchases, then QE2.  That triggered a moonshot in financial assets around the globe.

Back then, the Fed was grappling with four straight months of contraction in payrolls after a spurt of hiring earlier in the year. The economy had shed jobs throughout 2009 and there was a clear worry that the economy was rapidly losing momentum.

Unlike now, Reuters Polls were showing analysts unanimous in expecting the Fed to pull the trigger. In a poll taken in October 2010, all 52 analysts polled predicted QE2 would happen. A few weeks later, at the November FOMC meeting, it did.

This time around, there still appears to be enough conviction that the Fed will do another round of QE, perhaps more as an insurance policy than out of real worry that the U.S. economy, which is doing much better than Europe’s, is about to flat-line or even fall back into recession.

That means another round of money printing could involve buying government bonds – or possibly mortgage-backed securities, or both – but with an open-ended commitment.

Either way, financial markets would do well to pay attention to a recent line from policymaker Spencer Dale at the Bank of England, which also has been running the printing presses after cutting the policy rate to near-zero. Dale warned in a speech at Trinity College Dublin on the limits of monetary policy: “Beware confident economists”.

The Pavlovian-like response of some commentators to call for more monetary stimulus each time they observe weak growth is not sensible.

— With reporting by Rahul Karunakar in Bangalore. 

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