FOMC Preview: Is Bernankles Helpless?

by CC August 8, 2011 9:51 pm • Commentary

The FOMC will release a statement tomorrow at 2:15 PM ET following their one day meeting. There will not be a press conference following as Ben Bernanke keeps these for his 2 day meetings. Here are some thoughts from various observers. It sort of sounds like a consensus, so markets will react either positively or negatively depending on the aggressiveness or lack of aggressiveness by the Fed:


Chairman Ben S. Bernanke and his colleagues may prolong a pledge to maintain record monetary stimulus, said economists at JPMorgan Chase & Co., BNP Paribas and Goldman Sachs Group Inc. The Fed could do so by making a commitment to hold its $2.87 trillion balance sheet steady for an “extended period.” The Fed also may replace shorter-term securities with longer maturities to reduce rates on longer-term debt.

Calculated Risk

In July, during his Congressional testimony, Fed Chairman Ben Bernanke made it clear that another round of monetary accommodation (aka QE3) would depend on both a further deteriorating in the economic outlook and the renewed threat of deflation.

Clearly the economy is weaker than the Fed’s forecast in June, and there have been some initial signs of disinflation (Core PCE increased 0.1% in June or 1.3% annualized). However, based on Bernanke’s comments, I think the Fed will wait for further evidence on inflation, and I think a major announcement at the meeting tomorrow is unlikely.

However the FOMC statement will change. Here are a few key sentences from the June statement:

… the economic recovery is continuing at a moderate pace … The slower pace of the recovery reflects in part factors that are likely to be temporary … Inflation has picked up in recent months …
The unemployment rate remains elevated; however, the Committee expects the pace of recovery to pick up over coming quarters and the unemployment rate to resume its gradual decline … Inflation has moved up recently, but the Committee anticipates that inflation will subside to levels at or below those consistent with the Committee’s dual mandate as the effects of past energy and other commodity price increases dissipate.
… The Committee continues to anticipate that economic conditions–including low rates of resource utilization and a subdued outlook for inflation over the medium run–are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

“Moderate”, “temporary”, and “picked up” will all probably change. Growth has been worse than “moderate”, and inflation has subsided – but probably not enough for QE3. Still the Fed might make some changes as suggested by Jon Hilsenrath at the WSJFed Has Some Tricks Left, but None Are Magic

Since 2008, the Fed has assured the public that it wouldn’t raise short-term interest rates for an “extended period,” that is, at least several more months. It has been vague about plans for its vast portfolio of securities. The Fed now has a strategy—which it has disclosed—for gradually dumping the securities someday. The Fed can use its end-of-meeting statement to define “someday,” perhaps saying it will hold on to those securities for an extended period, too.

So the Fed might change the “extended period” language to include maintaining the current level of security holdings for an extended period. Not a huge change. QE3 is unlikely, but not impossible – although I think the Fed will wait for further evidence of renewed deflation fears, and also try to communicate any plans in advance.

USA Today

“I’m looking for (the central bank) certainly to do something,” says Nigel Gault, chief U.S. economist of IHS Global Insight.

Yet Gault, like many economists, says any move likely would involve a largely symbolic change in the language of its policy statement, rather than another big purchase of Treasury bonds aimed at lowering interest rates. And Conrad DeQuadros of RDQ Economics notes the Fed’s mission is to keep inflation and unemployment low — not to respond to stock market gyrations.

Plus, “It’s too soon to give up on expectations that growth will pick up” in the second half of the year, says Jim O’Sullivan, chief economist of MF Global.

Financial Post

“One thing we know about Bernanke is that he is willing to be extremely aggressive and he is quite creative at the same time,” said David Rosenberg, chief economist and strategist at Gluskin Sheff + Associates.

While Mr. Rosenberg thinks it is a little early for the Fed to embark on a new bond buying program, or QE3, he does think that is probably coming down the pipe. Other strategies he considers more likely in the near term include cutting the rate commercial banks pay the Fed to borrow to force them to put their money to work and rolling over government bond coupon proceeds into longer-dated maturities on the Fed’s balance sheet. The Fed could also adopt “extended-plus” language to convince investors that policy rates will remain near the floor for years, not just months or quarters.

“I would expect meaningful changes to the press statement alluding to at least one, if not all three of these strategies that Bernanke discussed roughly a month ago,” Mr. Rosenberg said.

Stéfane Marion, chief economist and strategist at National Bank Financial, expects the Fed to provide guidance in terms of changing the composition of its balance sheet, specifically a willingness to buy longer-term assets.

“They have to move [Tuesday], they have to alter their statement,” he said. “I think the Fed needs to be there to calm investors and ensure that credit markets do not become dysfunctional.”

Mr. Marion believes the key will be to make sure the downgrade of U.S. government debt does not lead to higher financing costs of the private sector.

As for implementing QE3, the economist thinks that is a possibility for Tuesday, but he doesn’t yet see the need as credit markets have not returned to the dysfunctional state seen in 2008.

Brian Trenholm, portfolio manager at Salida Capital, sees a QE3 announcement approaching sooner and sooner each day. He wouldn’t be surprised to hear the Fed suggest its willingness to do so in the days ahead and I thinks a formal announcement is not far off.

“I suspect that the market is effectively calling Bernanke’s bluff,” Mr. Trenholm said. “It is just testing how much pain the Federal Reserve can take before making a QE3 announcement.”


Instead, the Fed is more likely to begin any renewed aid campaign with smaller gestures.

The most basic measure available to the Fed is to promise that it will keep interest rates near zero for at least six months, or a year, or some other specified period of time. The central bank has promised after each of its meetings since late 2008 to keep interest rates near zero “for an extended period.” Earlier this year, Mr. Bernanke said that each renewal of that promise meant there would be no changes for at least a few months. A promise with a more distant expiration date would reduce uncertainty about at least one aspect of the economy.

The Fed also could make a similar commitment for the first time regarding its huge investment portfolio. Selling assets removes money from circulation, tightening monetary conditions, so a promise to maintain the portfolio for a certain number of months would have a similar effect. Moreover, the Fed has said it will start to sell assets before raising interest rates, so a promise about the portfolio also would extend the Fed’s commitment to maintain low rates.

Another available option would be to maintain the size of the portfolio, but to shift its composition toward bonds with longer terms. The Fed initially was reluctant to do this because those bonds would take longer to disappear naturally, but that concern may have been eased by the board’s affirmative decision eventually to shrink its portfolio through asset sales.

None of these options is likely to spur growth significantly. Economists generally agree that the economy is suffering from a lack of demand. The Fed can provide lots of money at low cost, but it can’t convince companies to build new factories unless they think there will be a market for their products. And it can’t convince consumers to spend money on those products if they don’t have jobs, or they’ve already borrowed more money than they can afford to repay.

“I don’t think any of these things would have a huge effect on rates,” Mr. Kohn said. “Could they help to reduce the cost of capital and ease financial conditions? Sure, and that would help encourage spending. But I think the major problem here is that people don’t want to spend, and that’s about confidence in the economy and the government.”