Milky wilkies

What can I tell you? The great boob has delivered. The great baby is lapping it up. QE3 is coming!

That’s the simple truth screamed by markets following Ben Bernanke’s testimony last night. The Dow went berko, the $US got trashed, gold hit record highs and commodities (oh commodities!) went limit up in everything from oil to rice.

But, notwithstanding risk trade euphoria, pretty much every international commentator of repute has interpreted Bernanke’s comments as signaling no QE3. What gives?

Let’s start Bernanke himself. The money paragraph of his testimony stated that:

Once the temporary shocks that have been holding down economic activity pass, we expect to again see the effects of policy accommodation reflected in stronger economic activity and job creation. However, given the range of uncertainties about the strength of the recovery and prospects for inflation over the medium term, the Federal Reserve remains prepared to respond should economic developments indicate that an adjustment in the stance of monetary policy would be appropriate.

Now to Jon Hilsenrath of the WSJ, generally considered something of a Fed mouthpiece:

Chairman Ben Bernanke acknowledged in his House testimony today that the Federal Reserve might need to take additional steps to ease monetary policy. “The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support,” he said.

This represents a slight shift in tone for the Fed chairman. In a press conference in June, Mr. Bernanke, in response to a question, laid out what the Fed COULD do if it saw a need to provide more stimulus to the economy. In his testimony Wednesday, he effectively said more stimulus MIGHT be needed, but only under certain conditions, namely persistent slow growth and a slowdown in inflation that again raises the prospect of Japan-style deflation.

Binyamin Applebaum of the NYT times is even less sanguine:

The Federal Reserve chairman, Ben S. Bernanke, gave a subdued account of the economy’s health Wednesday, saying that he expected the economy to grow at a moderate pace during the rest of the year, with unemployment declining “only gradually.”

The unexpected weakness is forcing the Fed to reconsider its determination early this year to refrain from new efforts to stimulate growth. While no additional actions appear imminent, Mr. Bernanke said in Congressional testimony Wednesday that the Fed would be prepared to act if necessary.

…Mr. Bernanke made clear Wednesday that a resumption of the central bank’s economic revival campaign faces a high hurdle. He said that the Fed would look for two conditions: economic weakness beyond current expectations and a renewed threat of deflation.

The first seems obvious to most people. The second, however, may the more important factor. The Fed’s decision to resume asset purchases last summer was made in large part because the central bank feared that prices might begin to decline, a phenomenon that can undermine growth because it causes people to delay purchases, fueling a downward cycle.

The FT took things the same way. Heavy hitters Gavyn Davies and Tim Duy did too (though the latter was addressing yesterday’s minutes). Both reckon that the Fed is badly divided and Bernanke unwilling to force though further stimulus. From Davies:

The financial markets seem determined to interpret today’s statement by the Fed chairman in a dovish light, but a careful reading of his words does not support that point of view. True, Mr Bernanke outlined the possible ways in which monetary policy might be eased further if recent economic weakness should prove more persistent than expected. But he gave equal weight to the possibility that “the economy could evolve in a way that would warrant less-accommodative policy”.

There was no hint in the text about which of these outcomes he considered the more likely. We already knew from yesterday’s FOMC minutes for the June meeting that the committee is split about the likely evolution of policy, and we were waiting to see today whether the chairman would throw his weight behind either the doves or the hawks. He failed to do either.

Mr Bernanke’s description of the economic background was almost exactly the same as he offered after the June meeting. Economic activity was described as weaker than expected, and not all of that weakness was attributed to temporary factors. In his central view, growth would rebound in the second half of the year, but there was considerable emphasis on the continuing weakness of the labour market. Meanwhile, on inflation, some of the recent rise was also attributed to temporary factors, but the entire emphasis was on the headline rate, which he said had been running at over 4 per cent so far this year. There was no mention whatsoever of the much lower core inflation rate, a previous favourite of the chairman’s.

In other words, his overall message was that the economy might be undesirably weak, but that inflation was too high for the Fed to be able to respond to that weakness. That is the main point which we should all take from today’s evidence: no imminent change in policy is likely.

Bernanke is caught in a trap of his own making. It he tells the truth, that the US economy is stuck in some slow motion depression, then the obvious consequence is more stimulus. But that same stimulus has now created such an extraordinary market expectation of an inflationary impulse through global commodity pricing that it reacts before he can stimulate, boosting inflation and preventing that very stimulus.

Basically, successive Bernanke QEs have de-anchored global capital market inflation expectations and that has stuffed his domestic mandate.

I see three possible scenarios.

First, the FOMC damns the lifeboats and delivers QE3, resulting in an epic blowoff in commodities and emerging market inflation.

Second, FOMC division persists and global markets continue to oscillate between hope and fear of free $USs.

Third, the FOMC sticks to its inflation busting guns and doesn’t stimulate until inflation expectations are re-anchored in markets.

The history of the FOMC still suggests to me that option one is the most likely.

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Comments

  1. Given the reaction from a ‘hint’ of further QE, imagine what we see when/if Bernanke follows through! Got Gold?

    That said I can’t help that feel things might be left to deteriorate further before the QE3 lever is pulled. Bernanke will probably try and talk the market up for a few months first (IMO).

  2. Good piece…how does Ron Paul fit into all of this. When he is going to get a chance to grill the Bernanke about how money printing fits in wit their vague mandate?

  3. Ok, so lets say Ben goes for option 1, namely…

    FOMC damns the lifeboats and delivers QE3, resulting in an epic blowoff in commodities and emerging market inflation.

    How does China handle such a scenario with the RMB still pegged to the US dollar, and the Chinese authorities desperately trying to keep a lid on inflation.

    I keep reading that Chinese inflation is all food inflation, but how can that possibly be so if hard commodities like iron ore and coal rip higher while the Yuan is still pegged to the USD?

    Meanwhile Chinese property prices keep rising, steel production is at record levels, and fixed asset investment is still growing much faster than consumption, despite the rhetoric to the contrary.

    How is any of this sustainable?

    Over to you Fanboy…

      • Problem is, its becoming increasingly clear most of Australia isn’t enjoying it. We just get lumbered with high interest rates and a strong dollar, while endlessly being lectured on how fabulously well we’re doing.

        • Interest rates are around historical averages, we can buy cheap stuff online, travel O/S cheaply and exchange rate ensures petrol isn’t killing the average joe at the bowser.

          Look for joy and you find it.

          • “Look for joy and you find it.”

            When the services and retail market starts shedding jobs then there wont be much joy.

          • Oh I agree, gloom is everywhere at the moment. Not always justified. And certainly nothing to do with mining.

            A lot to do with stagnant property, frugality at the checkout, global outlook, incompetent leadership, carbon tax.

            Not mining.

          • Oh I agree, gloom is everywhere at the moment. Not always justified. And certainly nothing to do with mining.

            Fanboy, the mining boom may have delivered a surge in national income, trade surpluses, and good economic growth compared to the rest of the developed world.

            But mining has also delivered a strong dollar and much higher interest rates than anywhere else. These are the main drivers of weakness in the non-mining economy.

            You’ve gotta take the good with the bad mate. You can’t keep claiming “its nothing to do with mining” when everybody knows there are pros and cons to the mining boom.

            The politics of envy can be very powerful. The miners are clearly worried that they will become a target if the slowdown in the non-mining economy intensifies.

            Slogans like: “Miners get rich while you struggle” are simplistic but effective much like Abbott’s “Great Big New Tax on Everything”. This boom is driving a giant wedge between the winners and losers. Its very divisive and very painful for a lot of people, and one day a politician is going to take advantage of this.

            Lets hope we learn to manage the boom better and spread the wealth around before that happens.

        • Miners are certainly not helped by the strong dollar.

          Why aren’t they squealing yet, like Meriton’s Harry Triguboff and the retailers?

          • Mav because they are to busy fighting the govt on Mining and Carbon Tax. Dont care what anyone says but a high Aussie dollar is not good.

          • Miners must contest the government on the mining and carbon tax – both unfair imposts on a valuable sector of the economy. They are quite correct in doing so.

            Apart from that, they really are too busy. There’s a boom on!

  4. What a surprise! QE1, QELite, QE2 didn’t work, and now QE3 will? CNBC say US banks are finally leading

    http://www.cnbc.com/id/43656157/Banks_Are_Finally_Lending_Again_Just_Not_to_You

    But my NY banker mate says some lending, and it’s very much a risk first scenario. But the money supply will expand a bit. US banks are having trouble borrowing so it’s not resolved yet.

    Let’s see, but monetary tinkering without fiscal, and structural reforms I expect QE3 (or what ever Ben does) won’t fix anything quickly.

    Finally, the GOP says they can’t afford for the US to default so maybe something will get sorted. This debt ceiling was always theatre, and historically they have raised the debt ceiling every time as far as I can find.

    • M2 has risen a bit faster than the long term average recently, which got inflationistas blogging about it this week. It seems to have been mostly from a rise in savings.

      The most recent credit numbers I saw — from a few weeks ago — showed consumer credit, ex-student loans, still sickly. The FRED will have the recent numbers.

      http://research.stlouisfed.org/

  5. Bernanke shot himself in the foot selling the last round of QE, when he explained it in terms of lifting the stock market. That PR error is making it that much harder to launch QE3. In saying that, imagine what would have happened to stocks if he came out last year and said the Fed believed there was a real risk of deflation.

  6. I was under the impression (and correct me if I’m wrong) that the previous rounds of QE were not really well subscribed and most of it has sat un-used?

    Therefore if BB (and co.) were to release more cheap $ into the market then would there be any real effect other than the Govt admission that the things just are not getting better?

  7. Ben hovers near the QE3 button, oil prices skyrocket, US economy tanks, huge political flak on the Fed – end of experiment.

    Not only will QE3 fail to work if actually used, it won’t even see the light of day.

  8. QE 3 will be used if the US is going to default. If the US govt sorts it out then dont believe there will be one. Will the US govt sort it. Yes as they been doing this till the 60’s and will wait till the final hour before they do it. Unbelieveable.

  9. Oh I agree, gloom is everywhere at the moment. Not always justified. And certainly nothing to do with mining.

    Fanboy, the mining boom may have delivered a surge in national income, trade surpluses, and good economic growth compared to the rest of the developed world.

    But mining has also delivered a strong dollar and much higher interest rates than anywhere else. These are the main drivers of weakness in the non-mining economy.

    You’ve gotta take the good with the bad mate. You can’t keep claiming “its nothing to do with mining” when everybody knows there are pros and cons to the mining boom.

    The politics of envy can be very powerful. The miners are clearly worried that they will become a target if the slowdown in the non-mining economy intensifies.

    Slogans like: “Miners get rich while you struggle” are simplistic but effective much like Abbott’s “Great Big New Tax on Everything”. This boom is driving a giant wedge between the winners and losers. Its very divisive and very painful for a lot of people, and one day a politician is going to take advantage of this.

    Lets hope we learn to manage the boom better and spread the wealth around before that happens, because it could get ugly.

  10. The issue still remains RBA/Treasury/Government policy.

    RBA determines interest rates, Treasury advises government on policy and we have a floating exchange rate.

    We just happen to have a raft of natural resources currently in strong global (China) demand. We are very fortunate to be in this position. It is somewhat unfortunate that this boom coincides with the stagnant property market, self-imposed consumer austerity and an uninspiring government Blame-layers are looking for an easy target.

    At the moment mining is it – in the good old Aussie tradition of cutting down tall poppies. We are dissatisfied bunch aren’t we? Most would be delighted to live in such a relatively robust economy.