Thursday, April 28, 2011

Did Ben Bernanke hint at QE3 during press conference?

U.S. Federal Reserve Chairman Ben Bernanke held his first press conference yesterday and a statement he made following that conference hinted at quantitative easing (QES). Read more about this in the full article from Money Morning.

While the first press conference ever held by U.S. Federal Reserve Chairman Ben Bernanke grabbed most of the headlines this afternoon (Wednesday), it was the post-meeting statement issued earlier in the day that grabbed my attention.

In particular, I zeroed in on the part about the policymaking Federal Open Market Committee (FOMC) regularly reviewing "the size and composition of its securities holdings in light of incoming information and is prepared to adjust those holdings as needed to best foster maximum employment and price stability."

Maybe I'm reading too much into this, but as a former longtime trader this is a subtle change in wording that says to me that "QE3" - a third round of "quantitative easing" - is on the way. After all, Chairman Bernanke said himself that inflation remains low, unemployment will not drop all that much and gross-domestic-product (GDP) expectations are falling.

So why not go to the QE "well" again?

After all, it "worked" before - U.S. stocks have zoomed some 90% as a result of the central bank's machinations.

However, the trick here is that "QE3" won't actually be QE3 in the manner that QE2 was QE2.

Instead of actually printing more money to purchase U.S. Treasury securities and other paper, the Fed is going to let QE2 end then start selling the $1.4 trillion in toxic "securities" that it acquired during the crisis. It will likely use those proceeds to buy yet more federal debt as a means of supporting more "normal" conditions - although those new securities purchases will probably be farther out on the yield curve.

As for the rest of yesterday's much-awaited - and closely watched - event, it was about what I expected - a lot of speaking, but not much clarity. (Speaking of "closely watched" ... I happened to be in the Money Map Press offices today; most of the staff and I stood together in a conference area and watched this event as a group, sharing insights as it unfolded.)

A Stunning Statement

I have to say that my jaw hit the floor when Bernanke put forth the notion of "transitory inflation" - especially when he stated that the Fed would "have to respond" to that if it is not "well anchored," and stated quite candidly that companies were having to pass those higher costs along to the public.

Last time I checked, inflation costs were anything but well anchored and companies are, in fact, passing along costs as fast as they can. McDonald's Corp. (NYSE: MCD), Nestle SA, and Wal-Mart Stores Inc. (NYSE: WMT) are just a few of the companies that have spoken out about the specific impact that higher component and ingredient costs have had on their earnings. Many have adjusted their guidance.

The press conference was historic. And it was also clearly stressful for Chairman Bernanke. Just for kicks, I ran a voice stress analyzer during the conference. And I was very surprised to see readings that were consistent with high stress or perhaps even evasiveness during the early part of his talk. (In fairness to Bernanke, I'd have been nervous, too.)

Once the question-and-answer session began, those stress readings came down significantly, most notably when Bernanke defended the Fed's actions as heroic and extreme. This suggests that Chairman Bernanke truly believes that part - whether anybody else does is another matter entirely.

Wall Street, of course, is off to the races again, with traders having concluded that the band is, indeed, playing on. Gold and silver rallied, while 10-year Treasuries saw yields rise 1.45% to 3.37%.

Historic Fed Press Conference

Today's Fed statement, historic Fed press conference and Q&A session followed a two-day meeting of the policymaking FOMC and was historic in a number of respects. First and foremost, the FOMC statement was released nearly two hours earlier than in the past - in order to make room for the press conference. I've referred to this as a historic Fed press conference because that's just what it was; it was the first time in the central bank's history - and it's nearly a century old - that the Fed leader made himself available immediately after a monetary-policy gathering.

During this first-ever Fed press conference, Bernanke defended the central bank's strategies and said that the Fed policies will help navigate the U.S. economy through a temporary economic growth slowdown and transitory inflation.

The press conference followed the Fed's announcement that it will continue with its purchase of $600 billion in U.S. Treasuries known as the second round of quantitative easing, or QE2, and will end the purchases in June without tapering.

Bernanke did not indicate there would be a third round - but as I noted earlier, many traders felt the central bank is headed in that direction.

The Fed will also maintain interest rates at an "exceptionally low" level between 0.00% and 0.25% "for an extended period" - the key language in place since March 2009 that signals no rate change is expected any time soon.

The Fed said that escalating prices of oil, energy and other commodities have pushed up inflation, but Bernanke reiterated that those increases aren't expected to translate into "core" inflation over the long haul.

Bernanke stressed to reporters that "longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued," and Fed policies would keep "transitory inflation" under control.

In economic projections released at the conference, the Fed raised its inflation outlook to 2.1% to 2.8% in 2011 from its January predictions of 1.3% to 1.7%. It expects inflation to fall to 1.2% to 2.0% in 2012, and to remain at 1.4% to 2.0% in 2013.

The Fed also said it expects the U.S. economy to grow at a rate of 3.1% to 3.3% this year, down from the 3.4% to 3.9% previously projected. The central bank expects growth to rise to between 3.5% and 4.2% in 2012 and to as much as 3.5% and 4.3% in 2013.

"The markdown of growth in 2011, in particular, reflects the somewhat slower than anticipated pace of growth in the first quarter," Bernanke said in prepared remarks before he took reporter questions. "I would say that ... most of the slowdown in the first quarter is viewed by the committee as being transitory."

Reporters were also eager to question the benefits of QE2. Bernanke said that it was never intended to be a panacea for the economy, but to help support recovery.

"I do believe that the second round of securities purchases was effective," Bernanke said. "We saw that first in the financial markets. The way monetary policy always works is by easing financial conditions. We saw increases in stock prices. We saw reduced spreads in credit markets. We saw reduced volatility. We saw all the changes in financial markets and quite significant changes one would expect if one were doing a normal easing of policy regarding the federal funds rate."

Analysts and economists expected these decisions and answers. While the economic recovery continues, Bernanke wants to maintain the central bank's record stimulus initiative, especially while unemployment is slow to improve.

So far, the central bank has purchased more than $2 trillion of U.S. Treasury and mortgage bonds to pump money into the economy.

Economists think the Fed is still at least a few months away from reversing any stimulus measures as it tries to help the sluggish job market.

The Fed expects the U.S. unemployment rate of 8.8% to fall to between 8.4% and 8.7% by the end of the year, and get as low as 6.8% to 7.2% by 2013.

The Fed's statement was very similar to its last policy announcement in mid-March. It said economic recovery continued at "a moderate pace," with the labor market "improving gradually." It also noted further increases in household spending and business investment.

"The Fed's view of the world hasn't changed very much," Gary Stern, former president of the Minneapolis Fed, said in an interview with Bloomberg Radio. "They continue to emphasize the transitory nature of inflation" and "continue to talk about the economy improving at a moderate pace."

The trouble spots identified by central bankers aren't a surprise - it focused on the "depressed" housing market and elevated unemployment rate as the economy's weak spots.

The Fed gave itself some flexibility with its securities holdings and said it "is prepared to adjust those holdings as needed," and would "pay close attention to the evolution of inflation and inflation expectations."

A Look at Interest Rates

The inflationary impact on the U.S. economy has been a hot topic as the more-hawkish Fed regional bank presidents have said policy changes might be necessary to control rising prices, but today's FOMC decision to keep rates low was unanimous.

Although Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser have said inflation concerns could lead to an interest rate hike later this year, Bernanke gave no clear indication of when to expect higher rates.

The Fed's refusal to raise rates comes when the European Central Bank (ECB) and central banks in many emerging economies are hiking theirs to curb inflation. China raised rates April 5 for the fourth time in six months, and the ECB followed suit on April 7.

Even though the central bank seemed unconcerned about inflation, investors acted otherwise and pushed up inflation-hedge investments gold and silver after Bernanke spoke. Gold rose $13.60 an ounce, and closed at $1,517.10. Silver climbed 90.8 cents and ended the day at $45.958 an ounce.

Investors have flocked to gold and silver as the U.S. dollar continues slipping. After the Fed statement the U.S. Dollar Index fell to 73.284, its lowest level since August 2008.

When asked about concern over how the Fed policies affected the U.S. dollar, Bernanke said he felt the central bank's decisions were the best they could do to keep purchasing power strong and create a stronger U.S. economy. He believes the policies will support a stronger, stable dollar in the long term, which is in the best interest of the United States.

The Fed's statement and Bernanke's policy defense gave a boost to markets that had waited all morning for the news before making moves. The Dow Jones Industrial Average rose 95.59 points, or 0.76%, to close at 12,690.96, while the Standard & Poor's 500 Index rose 8.42 points, or 0.62%, to finish the day at 1,355.66.

This article was republished with permission from Money Morning.

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