Ramblings of a Portfolio Manager

What to Expect From Jackson Hole
This Friday Chairman Ben Bernanke will speak at the Federal Reserve’s annual symposium in Jackson Hole, Wyoming.
Last year, Bernanke hinted that the Fed might embark on a second round of asset purchases to bolster the recovery, dubbed QE2. That speech kicked off a 28 percent rally in the Standard & Poor’s 500 Index of stocks that ended in a three-year high on April 29th.
At the last Fed meeting policy makers pledged to keep their benchmark interest rate near zero until at least mid-2013 and also said they “discussed the range of policy tools” available, giving hope that they may add to their record stimulus. That signaled that a QE3 might be on the table.
The whole world will be watching Bernanke’s speech, so if he chooses not to say very much, the global markets are sure to be disappointed. Though many market observers deny we will get a QE3, still there is hope among many that one will be forthcoming in some form.
Predictions are that Bernanke will suggest that the central bank will lengthen the average maturity for its $2.86 trillion of assets, which would help bring down long-term interest rates. The yield on the benchmark 10-year Treasury note dropped as low as 2.062 percent on Aug. 19 in New York, according to Bloomberg Bond Trader prices. Yields have fallen to record lows since the Fed announced its rate pledge on Aug. 9.
At the Fed’s last meeting Federal Reserve Bank presidents Charles Plosser of Philadelphia, Richard Fisher of Dallas and Narayana Kocherlakota of Minneapolis all voted against the Fed’s decision to keep the target for the federal funds rate at zero to 0.25 percent until at least mid-2013. Plosser and Fisher both said last week the pledge won’t help spur growth. The last time three policy makers dissented was in November 1992.
The central bank has kept the rate on overnight loans among banks near zero since December 2008. It also purchased $1.7 trillion of Treasury and mortgage debt between December 2008 and March 2010, and the $600 billion of Treasuries from November through June. The result was a temporary rise in risk assets but economic growth and job creation remains moribund.
Despite what many market watchers believe, the Fed is not out of bullets yet. Bernanke told Congress on July 13 the Fed does have stimulus options; these include buying additional securities, increasing the average maturity of its bond portfolio, lowering the interest rate on excess reserves and pledging to keep its balance sheet near a record high for a longer period of time.
When he foreshadowed the Federal Open Market Committee’s Aug. 9 decision to hold interest rates near record lows, the S&P 500 Index climbed 7.6 percent between Aug. 8 and Aug. 15. Unfortunately, it has since fallen 6.7 percent since amid concerns that U.S and global economic growth are faltering. Still, the Fed got a pretty good response to its decision, so they may deploy one or more of their remaining tricks.
The bond market seems to be already is pricing in an expectation that the Fed will announce new purchases of $500 billion to $600 billion, and investors looking for confirmation in Bernanke’s Jackson Hole speech may be disappointed.
The cost of living in the U.S. accelerated at an annual pace of 1.8 percent in July, excluding food and energy costs, which are typically more volatile. The gain was the largest in more than a year, according to Labor Department data released Aug. 18. That signals that, at least, QE2 was successful in staving off deflation.
However, the economy grew at a weaker-than-projected 1.3 percent annual pace in the second quarter, the Commerce Department said July 29, and growth in the prior quarter slowed to 0.4 percent, the weakest three-month period since the recovery began June 2009, suggesting that QE2 did little for the economy.
Morgan Stanley analysts have cut their estimate for expansion worldwide this year to 3.9 percent from a previous prediction of 4.2 percent. Part of the reason was “the drama” around lifting the U.S. debt ceiling, which helped depress financial markets and erode business and consumer confidence, the analysts said in a report last week.
Bernanke would have to overcome internal opposition to additional measures after his rate pledge led to the three dissents. There is less agreement this year among FOMC members that further easing is needed than there was a year ago when Bernanke spoke out. That suggests that the Fed chairman won’t hint at additional measures in Jackson Hole.
Still, Bernanke’s has shown he is willing to swim against the tide of dissent among the Governors in his decision to pursue the rate pledge with or without the full support of his fellow policy makers. So we the markets may get some, even if little comfort, this week.