MacroScope

More Fed QE: done deal or Pavlovian response?

“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.

Guarded Bernanke still manages to toss a bone to Wall Street and Washington

Ben Bernanke has done it again. In his much-anticipated speech Friday, the Federal Reserve chairman managed to tell both investors and politicians what they wanted to hear – that “the stagnation of the labor market in particular is a grave concern” – all while saying next to nothing new about where U.S. monetary policy is actually headed. That the Fed, as Bernanke also noted, stands ready to ease policy more if needed was well known to anyone paying attention the last few months. We also know that the high jobless rate, at 8.3 percent in July, has long been Bernanke’s main headache in this tepid economic recovery.

Still, in Jackson Hole, Wyoming on Friday, it was like Bernanke tossed a bone to the hounds on Wall Street and in the Beltway without even getting up off his lawn chair.

For markets, hungry as they are for a third round of quantitative easing (QE3), the “grave concern” comment says the high unemployment rate and mostly disappointing job growth since March gives the Fed little if any choice but to act. U.S. stocks climbed and the dollar dropped after the speech, with traders and analysts citing the remark. “‘Grave’ concern with labor market is striking,” said David Ader, head of government bond strategy at CRT Capital Group.

Four reasons the Fed could buy mortgages

The U.S. Federal Reserve will probably focus on buying mortgage bonds if it decides to launch a third round of quantitative easing or QE3 at its September meeting, says Columbia Management’s senior interest rate strategist Zach Pandl, until recently an economist at Goldman Sachs.
1. Since the second phase of Operation Twist just got underway, “it would be strange to announce outright purchases of Treasury securities.” 2. Fed officials have publicly noted that continued purchases of long-term Treasury securities “might compromise the functioning of the Treasury market — and undermine the intended effects of the policy.” 3. San Francisco Fed President John Williams “directly advocated” mortgage purchases and Fed Vice Chair Janet Yellen has said that “beyond the Twist extension, ‘it’s more likely that [the FOMC] would do things that would take a different form.’” 4. “Purchases of mortgage-backed securities may be considered less controversial than Treasury bond purchases amidst the charged political environment, just prior to the presidential election.”

Like over-hyped Olympian, Fed set to disappoint

Pity the Federal Reserve. Like an over-hyped Olympian, the U.S. central bank enters this week’s policy meeting with sky-high expectations and a high probability of disappointment.

Markets are salivating at the prospect of a decisive easing move when Fed policymakers emerge from their meeting on Wednesday. The S&P 500 is up 3.6 percent in the last four sessions as traders hold out hope the Fed will launch a third round of quantitative easing, or QE3, to blast the U.S. economy out of its funk. Stumbling job creation, manufacturing and spending, as well as a measly 1.5 percent GDP growth in the second quarter and serious spillover threats ahead from Europe’s debt crisis, all feed this thesis. Fed policymakers from Chairman Ben Bernanke on down the line to Cleveland Fed President Sandra Pianalto and James Bullard of St. Louis have also stoked the market with a more dovish tone the last little while. And yet, this is probably not the time for a big policy move.

Topping the list of reasons to disappoint – and to knock the market down to size – the Fed probably doesn’t want to front-run the July employment report that’s due on Friday, and which will give a fresh sense whether the spring-summer slump in the labor market is temporary or more permanent. Waiting until the Fed’s next scheduled meeting, Sept. 12-13, would give policymakers the added benefit of the August jobs report. And speaking of front-running, the U.S. central bank may not want to get out just ahead of the European Central Bank’s policy decision on Thursday. If, down the line, things get really ugly in Europe – or if the U.S. Congress sends the country off the so-called fiscal cliff – the Fed will probably want to have the QE3 bazooka ready in its arsenal.

Excuses, excuses: The problem with ‘structural’ explanations for U.S. unemployment

It’s an arcane economics debate with all-too-real implications for U.S. monetary policy: Is high unemployment primarily the result of “structural” factors like skills mismatches and difficulties relocating, or is it largely due to insufficient consumer demand in a weak economic recovery?

The answer to that question may help determine how much further the Federal Reserve is willing to push its unconventional measures to bring down the jobless rate, currently stuck at 8.2 percent. If unemployment is cyclical, economists say, it would be more likely to respond to looser monetary conditions.

Research from Berkeley professor Jesse Rothstein, published earlier this year and featured recently on the National Bureau of Economic Research’s website, represents one of the most thorough academic efforts to date to discredit the structuralist version of events.

Fed doves ‘will not be patient’

Ellen Freilich contributed to this post

The Fed did the twist. Will it shout as well? There has been some debate among economists about whether the U.S. central bank might launch a third round of outright bond buys or QE3 given that it just prolonged Operation Twist.

But a truly grim report on the U.S. manufacturing sector from the Institute for Supply Management, if coupled with further evidence of a deteriorating labor market, could certainly induce policymakers to press their foot to the monetary accelerator.

Not only did the index slip below 50 in June, pointing to a contraction for the first time in three years, but the reading of 49.7 was lower than the lowest forecast in a Reuters poll of economists. Moreover, the subcomponents showed the biggest drop in new orders since the aftermath of the Sept. 11 attacks in 2001.

Get ready for QE3 if things don’t get better soon

Ben Bernanke appears to be reluctantly gearing up for a third round of large-scale Federal Reserve bond buying, so-called QE3. Millan Mulraine of TD Securities captures just how likely further monetary easing is becoming following the Fed’s decision on Wednesday to expand Operation Twist.

The burden of proof may now be on the incoming data to prove that a third round of large-scale asset purchases may not be necessary.

Just under two months before the central bank’s yearly gathering at Jackson Hole – where Bernanke announced QE2 – the Chairman emphasized the path of the job market will be a key driver of any decision to further expand the central bank’s $2.8 trillion balance sheet. He told reporters at a press conference:

As financial conditions tighten, Fed may have to run to stay in place

Seemingly lost in the talk about whether or not the Federal Reserve should ease again is the idea that financial conditions have tightened and the U.S. central bank may have to offer additional stimulus if only to offset that tightening. Writes Goldman Sachs economist Jan Hatzius:

Alongside the slowdown in the real economy, financial conditions have tightened. Our revamped GS Financial Conditions Index has climbed by nearly 50 basis points since March, as credit spreads have widened, equity prices have fallen, and the U.S. dollar has appreciated.

Goldman’s new GS Financial Conditions Index is based on the firm’s simulations with a modified version of the Fed’s FRB/US Model. It includes credit spreads and housing prices and has a closer relationship with subsequent GDP growth than the previous version of the index, the firm says. A 100-basis-point shock to the GSFCI shaves 1-1/5 percent from real GDP growth over the following year. Still, it’s not quite as bad as it sounds:

Fed policy: So many risks, so few tools

Chris Reese contributed to this post.

A barrage of rotten economic news around the world has suddenly and vigorously reawakened the prospect of additional monetary easing by the Federal Reserve – most notably a report on Friday showing job growth slowed sharply in recent months.

William Larkin, portfolio manager at Cabot Money Management in Salem, Mass., said:

The chance of another recession is on the table, no question about it. It might force the Fed to develop another growth strategy like a QE3.

Inflation no obstacle to more Fed easing

Another reason the Federal Reserve may have additional room for monetary easing: Inflation expectations fell sharply in May, according to the latest Thomson Reuters/University of Michigan survey of consumer sentiment. Inflation expectations five years out dropped to 2.7 percent in May, the lowest since January. Fed officials often say expectations are a key leading indicator of actual price increases.

Daniel Silver, economist at JP Morgan:

This level of longer-term inflation expectations is towards the bottom of the range that has been reported in recent years – 2.7% has been hit on several occasions (most recently between October 2011 and January 2012) and 2.6% was only reached back in December 2008 and March 2009, early on in the crisis period. Most other inflation measures that the Fed watches (including core PCE inflation and the 5yr-5yr breakeven inflation rate) have signaled that inflation expectations are still anchored and underlying inflation pressure is modest.

The downshift comes in the wake of inflation figures for April that also pointed to a tame price environment. This is why Eric Green at TD Securities argues “U.S. inflation favors the doves.”: