MarketBeat (WSJ Blog) – Drumbeat’s Getting Louder: the Fed Must Save the World
The market took the ECB news, brushed it off for the appetizer it was, and turned to the main attraction: the Fed. The market is setting up for something big from officialdom. We are seeing and hearing a lot of chatter. This post from Business Insider captures the gist of it: the world’s central bankers are getting some kind of rescue package together. Europe is on the edge of the abyss, again. Greece, the first domino, has been completely thrown off the front page in favor of Spain, a far bigger domino up the line that seems poised to topple. A response must come, but the eurocrats, as they have for three years, seem incapable of action. If they can’t act, somebody must. It’s not just QE3. It’s bigger. The drumbeat are pounding for another coordinated response, something like the six-bank swap lines deal from last year. The Center for Economic and Policy Research issued a call on Monday for the Fed to intervene to save Spain (brought to our attention from East Shore Partner’s always sharp strategist, Joan McCullough.) Another “Lehman moment” is approaching, the group argued. The ECB won’t act. A slide into recession or worse could result. ”Since the euro-zone crisis is affecting unemployment in the United States, and threatens to raise it further, it is within the Fed’s mandate to act in this situation,” the group said. Within the Fed’s mandate, to bail out a sovereign nation in Europe. This is what it’s come to. The Fed must save the world. As if that’s possible.
The Wall Street Journal – Officials Say Fed May Need to Act
A trio of Federal Reserve officials warned of risks to the health of the U.S. recovery and said the central bank might need to take new actions to support economic growth. Most notable among them, Fed Vice Chairwoman Janet Yellen cited risks that the rate of inflation could drop below the Fed’s 2% goal or economic growth would slow. Fed action might be justified merely “to insure against adverse shocks” that might derail the recovery, she said, adding it could also be needed if the Fed concludes the recovery “is unlikely to proceed at a satisfactory pace.” “I am convinced that scope remains for the [Fed] to provide further policy accommodation,” either with assurances that interest rates will stay low or by expanding the central bank’s already sizable holdings of long-term securities, she said. Among her concerns were strains in financial markets and uncertainties related to U.S. fiscal policy. Meanwhile, presidents of the Federal Reserve Banks of Atlanta and San Francisco both expressed concerns Wednesday that turmoil in the euro zone could derail the U.S. economic recovery. “I am giving more weight and higher probability to a negative influence on our economy coming from Europe,” Atlanta Fed President Dennis Lockhart said in a speech in Ft. Lauderdale, Fla. If modest economic growth no longer seems realistic, “further monetary actions to support the recovery will certainly need to be considered,” he said. He said an option “on the table” was extending a $400 billion bond-buying program, known as “Operation Twist,” in which the Fed is selling short-term securities and using the proceeds to buy long-term securities.
Real Time Economics (WSJ Blog) – 2012 Feeling Like 2008, Except Then Policy Makers Were Ready to Act
The past few weeks have seen the same “we’re going to hell in a handbasket” jitters that were evident in September 2008 — before the financial markets collapsed. This time the nail-biting centers on Greece and Spain, but the reactions are the same: Stock prices swing widely, businesses are reluctant to expand payrolls or facilities, consumers feel gloomier…What is critically different this time from 2008 is the lack of help coming from monetary or fiscal policy makers in both Europe and the U.S. The Federal Reserve slashed interest rates to near 0% in 2008 and introduced forms of quantitative easing since then. Today, the Fed is talking up its capability to do more — but central bankers themselves seem split on the next policy move. More importantly, the impact on growth from QE2 and “Operation Twist” seems questionable; what good would QE3 do to stimulate demand among businesses and consumers? Additionally, if more accommodation weakens the dollar, the euro zone, already in recession, will face even tougher growth prospects. Across the pond, the European Central Bank is reluctant to help pull the euro zone out of its death spiral. It’s all about price stability for the ECB even as the bank acknowledges economic growth faces “downside risks.” ECB President Mario Draghi instead implied politicians need to step up. “I don’t think it would be right for monetary policy to fill in for other institutions’ lack of action,” he said at a Wednesday press conference. Yet three years into the crisis, euro-zone politicians still can’t agree on how to stave off a euro split.
Bloomberg.com – Europe’s Last Chance to Save Itself
At the summit planned for the end of this month, Europe’s leaders need to aim higher than their default strategy of “do nothing, see what happens.” Two new proposals are being discussed: a “banking union” to shore up the EU’s beleaguered financial system and a “redemption pact” to guarantee the solvency of Europe’s debt-stressed governments. Although neither plan would completely fix the problems, both are worth pursuing.
The Independent – Eurozone divided as time runs out for Spain
Bailout now ‘inevitable’ despite official denials
The eurozone sovereign debt emergency showed no signs of abating yesterday as the Spanish government desperately haggled over the terms of its expected bailout and the European Central Bank refused to ease monetary policy for the currency bloc, despite signs of stricken European economies sinking still deeper into recession. Madrid’s Economy Minister, Luis de Guindos, insisted once again he was not making any plans to follow Greece, Portugal and Ireland in requesting a bailout from the European Union and the International Monetary Fund. But, behind the scenes, Spanish ministers accept that an external rescue of the country’s beleaguered banking sector is now necessary. Spain is trying to persuade its European partners to allow the European bailout fund to inject capital directly into its banks, rather than diverting the money through the state. Madrid fears that a full-blown national bailout would be accompanied by an onerous EU/IMF inspection system.
The markets appear to be ready/hopeful for the big QE3 announcement by Bernanke this morning. This testimony is being viewed as “Jackson Hole 2.0,” referencing the August 2010 speech in Jackson Hole, WY when Bernanke all but announced QE2. Will this happen while the S&P 500 is still at 1,315 and 10-year TIPS inflation breakeven rates are at 2.15%? To expand on the answer we gave to this question in the chat window at the top of this page:
The Jon Hilsenrath story yesterday seems to point to further stimulus in the near future. Whether or not that happens today when Bernanke speaks in front of Congress is anyone’s guess, but between yesterday’s rally in the stock market and the pop in the futures market this morning after China’s rate cut, traders appear to be positioning for big news today. Reading the highlighted quotes in the stories above, the press gives the impression that further stimulus is a foregone conclusion.
With a TIPS 10-year inflation breakeven rate of 2.15% and the S&P above 1300, announcing QE today risks overheating the markets later on. This could lead to the Federal Reserve cutting any QE short. There is also going to be a lot of pushback from the hawkish governors given the current level of the stock market and inflation statistics.
What does Ben do if we are at 1475 on the S&P 500 and a breakeven rate of 2.90% before QE3 starts? Do you cancel it before it starts? That is the risk. Starting now risks too much inflation.
Click to enlarge:
Source: Bianco Research