Bernanke Dodges Bullet; Markets Celebrate

Good Evening: As Thursday dawned, market participants were a little on edge. Yesterday’s FOMC statement was found a bit wanting by most investors, leaving them concerned about not only the Fed’s exit strategy from Quantitative Easing but also Chairman Bernanke’s exit strategy for a successful escape during today’s Congressional hearings on the BAC-MER deal. Those worries proved premature on both fronts, and the U.S. capital markets celebrated with a solid up day for both stocks and bonds. Longer term, however, I wonder if Mr. Bernanke and the Fed can escape political challenges to their independence during the next twelve months.

There were some interesting gyrations in our stock index futures overnight, perhaps due to some position jockeying by the off-hours trading crews ahead of Mr. Bernanke’s testimony. With the Russell indexes facing a large rebalancing tomorrow and with the end of the second quarter next week, our markets may see some choppiness that has more to do with portfolio positioning than with shifting fundamentals. This morning’s economic data were another potential source of volatility, but they more or less offset one another. Initial and continuing jobless claims were slightly worse than had been expected, while the final revision to the Q1 GDP figures was slightly better than the forecasts. Stocks opened with smallish losses as all eyes turned to the Bernanke hearings. “What does Congress have on the Chairman — and can he survive?” were the questions posed on T.V. and on trading desks.

Equities had already reversed their early downticks when Mr. Bernanke’s prepared testimony was released at 10am edt. The nascent rally under way grew legs once it was apparent that Mr. Bernanke had come prepared to defend himself quite vigorously (see below). As the hearings dragged on, it looked less and less likely that Congress would be able to lay a glove on the Fed Chairman, let alone disclose the type of information that might lead to a TKO (Bernanke’s resignation).

Stocks continued to rally, and they went higher still when the Fed released a statement addressing the status of some of the alphabet soup lending programs they’ve been sponsoring (see BAC-MER piece below). One program was closed and a couple of others shrank a touch, and while these moves won’t have much impact on the credit markets themselves, the downshifting nature of the announcement implied the Fed is cognizant of the need for an exit strategy for all the liquidity created by these facilities. This news was quite welcome, since many analysts and investors were disappointed yesterday when the widely anticipated FOMC statement didn’t address these issues at all.

With this morning’s twin concerns about the Fed now addressed, market participants were handed a final bit of good news from the bond market. A seven year note auction was quite well received, capping off a very successful week for the Treasury. The major averages made one final push to the upside in the wake of the auction results, and stocks prices then went mostly sideways for the rest of the afternoon. The final tally left every index with gains of more than 2%, with the Dow Transports (+4.4%) leading the way for the third straight day. As mentioned above, Treasurys also enjoyed solid gains as yields declined between 7 and 15 bps. The dollar weakened a touch and commodities exploited this downtick in the greenback. Led by a very firm energy sector and with some help from the metals complex, the CRB index rose 1.4% today.

Ben Bernanke came out swinging in his own defense today, quelling (for now) fears that his job might be on the line over the Fed’s role in the Bank of America–Merrill Lynch merger. Prior to the hearings, no one really knew if the Committee calling him to the microphone had some real evidence of impropriety or if the politicians were just grandstanding for the voters back home. Luckily for Mr. Bernanke, it was the latter. The most humorous moment came when Mr. Bernanke told those assembled that the Fed “acted with the highest integrity throughout its discussions” (over the BAC-MER deal). Some of the elected officials looked momentarily stumped over the meaning of the word “integrity”, and I thought they would have to turn to their staff flunkies for an explanation.

I bring it up because the hearing itself was a farce. As usual, Congress is focusing on the wrong issue, choosing to overanalyze an aftermath sideshow to the financial crisis when they should be focusing their attention on the root causes of the crisis and how to prevent them in the future. Given his easy money policies that fostered the credit bubble, his advocacy of dismantling the financial regulatory framework, and the general abdication of monitoring lending practices that were allowed to become dangerous under his stewardship, it should have been Alan Greenspan sitting in the hot seat on the Hill — not Mr. Bernanke. Mr. Bernanke was handed this mess by the Maestro, who was aided and abetted by the very Congress that spent the morning grilling his successor.

And, speaking of successors, another unseemly aspect of today’s proceedings lies in just who in the administration leaked the BAC-MER documents to Congress. The prime suspect, who — of course — will have left no fingerprints, is none other than the man who covets Mr. Bernanke’s job. I am speaking of Larry Summers, and if he somehow convinces President Obama to ditch Mr. Bernanke when the current Chairman’s term expires next year, it will be a disaster. Not because I revere Helicopter Ben, mind you, nor because I have a problem with Mr. Summer’s political party. I would shed no tears if Mr. Bernanke were suddenly replaced by a tough, hard money advocate like Paul Volcker (see the fascinating article about this man of character below), but though they share the same party affiliation, Mr. Summers is Mr. Volcker’s polar opposite.

Summers contributed to the current crack up when he championed the abolition of Glass-Steagall while working for President Clinton, and he also pushed for the law that banned the regulation of the very credit derivatives that have wrought so much damage during these past 24 months. In addition to being “part of the problem” that brought us here, Mr. Summers is an active member of the current administration, one who helps set economic policy for the President. I can think of no other potential appointee who would be viewed as a greater risk to the Fed’s independence than Mr. Summers. It’s a prospect that would not sit well with investors, especially our global creditors. Why else would Warren Buffett offer the glowing endorsement he gave Chairman Bernanke yesterday? As someone who knows well the dynamics in the current administration, the Oracle of Omaha knows full well who Mr. Obama would call upon as the next Fed Chair. The risk such a fate might befall Mr. Bernanke in the wake of today’s hearing is why market participants were nervous this morning. His swift dispatch with the proceedings helped both stocks and bonds soar this afternoon.

Again, my beef with Mr. Summers isn’t personal, nor is it political; it is one grounded in ideological common sense. If we are going to have a central bank in this country, it needs to have the independence we preach about to the rest of the world. Thus, while Bernanke dodged a bullet today, the markets rightly fear there is still one out there with his name on it. It may never happen, but if Summers some day replaces Bernanke, investors will likely react by selling bonds and buying precious metals. In the eyes of investors at least, we might as well just mail the keys of the Eccles building to 1600 Pennsylvania Avenue.

— Jack McHugh

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