Bernanke-Draghi: Jackson Hole vs. Leen’s Lodge
David R. Kotok
August 27, 2012
“Five years into the financial crisis, the exit for central banks from their stimulus efforts is nowhere in sight and even may be getting further away.” (Richard Barley. “Central Banks’ Incredible Lightness of Easing.” Heard on the Street. WSJ.com. August 26, 2012)
Second-quarter GDP revisions will likely put the growth rate of the US economy above two percent. That estimate is high enough to stop any QE3 action from Jackson Hole. We expect lots of Fed rhetoric and some mixed comments as media interviews occur. The media will have nothing to do but cover a conference where presentations will be made and decisions will be deferred. The Fed retreat in Jackson Hole is the place for the national media to earn its pay.
Mario Draghi has already declared to do “whatever it takes.” We do not expect anything new from Draghi or the European Central Bank until several events occur. They are scheduled for September.
The troika (IMF, European Commission, and ECB) will inspect Greece but will not yank funding. Greece will likely pass the tests with a B+, a C-, or an intermediate grade that suggests Greece is trying but needs to do a little more, to try harder and achieve more results. Greece will get enough money to roll back the debt it owes to the institutions the troika represents.
That paves the way for the next issue. The German constitutional court decision (currently scheduled for September 12, 2012) may say yes to the ESM (European Stability Mechanism), it may say no (this is highly unlikely), or it may say yes with certain modifications. We do not know. Finding a form to complete the ESM is the most likely outcome. Furthermore, the brain trust that operates the eurozone will come up with a different mechanism if no form is found by the constitutional court.
Once the ESM is in place, it can be funded through the ECB, which means a very large QE at the ECB level. Perhaps a banking license will be granted to the ESM, and several countries will become immediate recipients. Spain, Italy, and Ireland will be among them. There will suddenly be a very large liquidity infusion of newly created euros that will drive down interest rates and narrow the spreads among the various members of the eurozone. That is the outcome to expect in September.
Questions: Will any of this improve the economic growth rates of the European countries? Perhaps some improvement will occur in some countries, but will those improvements be dramatic? That is not clear, since structural reforms have not been implemented meaningfully in those countries. What will this do for banking systems in countries like Spain? It should amount to some modest help, since it is a subsidy to the banking system. Not a lot of help, since the banking systems still hold assets that are under water and inadequately reserved for the upcoming damages. Will runs on banks in countries such as Greece, Portugal, Spain, and Italy subside, so that their banking systems can regain functionality? Perhaps there will be some restoration of confidence and the bleeding will lessen.
What does all of this mean for markets? That is the biggest unanswered question. Foreign markets are watching China’s weakness. The second largest economy in the world is struggling with serious questions about its regrowth. In Europe, growth rates are not expected to improve even if the ECB liquidity infusion occurs.
In the US, the slow-growth approach and fiscal-cliff uncertainties of an unclear election outcome impede an economy that is struggling under the burden of a large negative output gap (read: high unemployment). There is a realization that the Federal Reserve can not, will not, and should not do any more. It does not have a reason to.
The above leave us to end August with a large uncertainty premium.
What to do? The first thing to do is avoid 70 thousand of your closest personal friends on the west coast of Florida. Some of them will be in Sarasota, but they will miss us. The second thing is to try to duck the damage that may be done by Hurricane Isaac. Isaac’s most likely impact is on oil-drilling platforms in the Gulf of Mexico. It may go on to dump copious amounts of rain in sections of the US that need it.
We will escape to Maine and chase some friendly bass or pickerel in the pristine waters of the St. Croix River watershed at Leen’s Lodge. Our small group will talk about the economics and politics of the world and look for pre-autumn color. At last check there were a few empty spots at the lodge, in case any venturesome souls want to head in that direction at the last minute. We wish our readers all the best for the Labor Day weekend. There is much to observe and plenty of fireworks coming in September.
For the size of those growing central bank balance sheets and for the interest rates and credits spreads, see the weekly updated series in the middle of our homepage, www.cumber.com.
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David R. Kotok, Chairman and Chief Investment Officer
