Report from Jackson Hole
David R. Kotok
July 13, 2013
At Jackson Hole this week, Federal Reserve Bank of St. Louis President James Bullard presented a slide demonstrating that in a previous round of QE policy the inflation rate rose near the 2% target of the Fed (Federal Reserve). He then noted that during the present round of QE the year-over-year inflation rate is closer to 1%. He also noted that rising commodity pricing contributed to a higher inflation rate during the first round of QE and that the present trend is downward as commodity prices continue to decline worldwide.
My takeaway from Bullard’s presentation is that he is worried about falling inflation. My sense is he does not want to see the Fed in a position where the inflation rate approaches zero and the Fed’s actions to remove some stimulus turn out to exacerbate volatility, thereby undermining the effectiveness of QE policy.
Federal Reserve Bank of Philadelphia President Charles Plosser noted that the employment situation is improving in the US. He particularly noted the revisions outlined in the last employment report. Plosser is concerned about waiting too long before tapering and about getting to a more neutral policy stance. He outlined his arguments thoughtfully and eloquently. He noted the characteristics of the forecasts by members of the FOMC (Federal Open Market Committee), of which he is one.
My takeaway from Plosser’s comments is that he is worried the Fed will wait too long. Listening to both Bullard and Plosser, the audience could observe the collegiality of these two FOMC members. The skill with which they both argued their points of view, as well as the data they presented, was impressive.
The audience of over 200 at Jackson Hole was divided on its viewpoints. One of the Fed presidents pointed out the surveys conducted of audience opinions showed the same types of divisions that occur within the FOMC.
While he was not at Jackson Hole, Ben Bernanke was the subject of many conversations during the roundtable discussions and conference. His speech last week triggered market changes. It appears as if he attempted to undo some of the miscommunication that occurred in prior weeks. He seems concerned about the rise in home mortgage interest rates and how it may slow housing’s recovery.
Ben Bernanke and his potential successor were also the subject of much discussion. In a survey of the 200 in attendance, Janet Yellen emerged as the front-running choice, with Tim Geithner and Larry Summers falling in line behind her. A small portion of the audience felt it would be someone other than these three. Of course, everyone admitted that this is a political decision, and the sooner it is made and vetted in the marketplace and among the general public, the better for everyone. That said, our takeaway from the conversation is that a decision on succession is not expected until early autumn.
Bernanke has a chance to clarify things again when he testifies this week. We believe he will affirm the statement he made last week in the Q&A period following his speech: “You can only conclude that highly accommodative monetary policy for the foreseeable future is what is needed in the US economy.” There is no reason to believe anything will change in his testimony this coming week. We think he will reaffirm his position powerfully. That position is the basis on which we believe that the Bernanke policy will survive Bernanke as Chairman and that the near-zero interest-rate policy will remain in place for several more years
The Jackson Hole meeting was packed with terrific information. I will not repeat what is available on the GIC (Global Interdependence Center) website. Readers can get all the slides, programs, and comments at www.interdependence.org.
The investment panel responded at the end with another round of diverse opinions. Those presentations, too, are on the GIC website.
Our takeaways from conversations at Jackson Hole will be applied at Cumberland to our portfolio management. The conversations basically indicate that the federal funds rate, currently anchored between 0.0 and 0.25 percent, is not going to change for another couple of years. The Fed may enlarge its balance sheet to over $4 trillion before it levels things off and begins to gradually allow maturities to roll off. Or the Fed might enlarge its balance sheet somewhat less and peak at $3.8 trillion. Or it could do more and go to $4.2 trillion. Our conclusion is that the exact level does not make much difference at this point.
The key interest rate set by the FOMC is near zero. It has been there for about five years. We have not seen any inflation pressure. We still see a gradual healing of the employment situation, with an overhang of millions of underemployed or underutilized workers. It is likely to take many years for US employment to become more robust and stable.
At very low interest rates there is an upward bias in asset prices, including prices for real estate, stocks, collectibles, and other assets for which valuations depend upon interest rates as a discounting mechanism.
Our bias is to remain fully invested in the US stock market, which we think will head higher and close higher at the end of this year. Our bond accounts emphasize spread product, particularly in the municipal bond area. Tax-free bonds are cheap.
David R. Kotok, Chairman and Chief Investment Officer, Cumberland Advisors