Bernanke spoke today in Jackson Hole, Wyoming. While it’s tempting to deliver some commentary on the wisdom of government workers jetting off to Jackson Hole on the public dime I’ll skip it and get on to the analysis of the speech. Who knows maybe I’ll shoot a resume’ over to the Fed so I can write these updates from Jackson Hole instead of Memphis, TN.
The full speech is 20 pages long. Because I know that bankers are busy people I’ve taken the liberty of summarizing this riveting piece of Central Bank literature to its core concepts so that you can get back to counting up how much money you made selling Fed Funds last night.
The short story:
- Recovery slower than expected
- Consumers shoring up personal balance sheets
- Business spending will slow from pace of first half
- Housing will stink for a while
- High unemployment will be persistent and disconcerting
- Don’t expect any significant disinflation
- Inflation should remain low then slowly rise toward target
- Fed discusses four “tools” for providing additional stimulus
- Reasonable to expect some increased growth in 2011
The bulk of his commentary was used to introduce and discuss the “tools and strategies” available to the Fed to fight any further deterioration in economic conditions. These are the tools discussed internally at the Fed and Bernanke went out of his way to provide color on the plans as well as the pro’s and con’s of each option. I thought this was a remarkable amount of clarity from a Fed Chairman…the Fed went out of their way to let everyone know what they are considering as well as acknowledging the risks, payoffs, and in some cases probability of using the tools.
The four tools (and I’m not referring to the other Fed governors)
1 – Additional Asset Purchases
Pro’s – Lowers borrowing costs quickly
Cons’ – Lack of experience with this option creates uncertainty on its quantitative effects.
My take – The Fed will likely use this as the main tool. The others all provide only modest or temporary changes in rates.
2 – Ease financial conditions through communication (i.e. change the language in the FOMC statement)
Pro’s – Quickly communicate change
Cons – Difficult to convey policy intentions with sufficient precision and conditionality
My take – They can try to talk the market one way or the other but ultimately they need to “walk the walk” so to speak. Talk will only get you so far…if the market doesn’t believe that you have the ability or the desire to follow through then the effect of your statements will be short lived. A recent example of this was the introduction of their asset purchase program…the market jumped on the announcement but then came right back to where it started when they realized nothing was being done yet. Ultimately the Fed had to start actually buying the bonds to get the effect they wanted. Words are cheap and fleeting…but two trillion dollars leaves a mark.
3 – Lower the rate paid on Excess Reserves (currently 25 bps)
Pro’s – Would provide banks incentive to increase lending to non-financial borrowers or participants in short term money markets
Con’s – Used in isolation the effect of this tool would be very small
My Take – Wouldn’t be used on its own…would be used as part of a much larger plan. This might be used if they get into a bigger fight than they expected and need to pull out all of the stops. They might be able to implement this to get a bit more juice out of a bigger squeeze so to speak.
4 – Increase the inflation target –
This should fall in the “honorable mention” category. Bernanke dismisses this thought outright by stating that there is no support for this idea at the FOMC. If they aren’t considering it I figured there’s not much point in describing it…just know that if you hear anyone speaking about raising the inflation target that it’s time to go grab a cigarette or play some solitaire.
The Market Reacts
Market reaction has been notable. Since the release of this speech the 10-year Treasury has pulled back almost a point and a half to trade at 2.63%. That is a full 20 bps more yield than the 2.43% level it hit earlier this week. The 30 year is seeing a bit more volatility than it’s used to in recent trading sessions. It is off just over 3-points to trade at 3.765%...a full 30 basis points higher than yesterday’s low of 3.46%.
Will it last?
It doesn’t feel like the beginning of a sustained pullback to much higher yield levels. The fundamentals that drove us to this point on the curve are still very much with us. The only difference is that today we just got word that the Fed has some plans in place if things should get worse. This speech is a classic example of the use of statements to move the markets. We’ll see how long the impact of this speech lasts…if it’s like prior examples of the strategy then we could easily be back to where we started before long.
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