This week’s major market-moving event was Fed Chairman Ben Bernanke’s speech on Wednesday to the National Bureau of Economic Research. He made it unequivocally clear that no “tapering” of the central bank’s bond buying program from the current $85-billion-a-month pace is likely to occur soon. These comments are significantly different from the impression he left a week earlier. At his press conference following the meeting of the Federal Open Market Committee (FOMC), Bernanke said he was “deputized” by the rest of the policy-setting panel to lay out its expected timeline for policy tapering. The issue with this “timeline”, Bernanke noted, is that the tapering would be dependent upon the economy expanding in accordance with its forecast, especially with a continued growth in jobs to bring down the unemployment rate meaningfully. If these best-laid plans come to fruition, the FOMC would start to taper their purchases later this year and wind them down by mid-2014. However, it appears that when he made this comment last week, he didn’t emphasize the contingencies that would first need to be met before tapering would begin; he cleared this up in his meeting this week.
Chairman Bernanke will likely continue to “walk back” his comments from last week, as the overall reaction was much worse than they must have predicted – for instance, mortgage applications fell 15% the week after his comments on tapering back monetary stimulus. Moreover, the minutes of that FOMC meeting, which were released only a couple of hours before the Fed chief’s talk, indicated a significant contingent on the panel wanted to end the bond buying even sooner, by year-end. As the policy directive indicated, the Federal Reserve Bank of Kansas City’s President Esther George dissented against the “continued high degree of monetary accommodation,” which she saw as risking financial and economic imbalances.
But Chairman Bernanke left a markedly different impression Wednesday. Sounding very much at ease for someone who is likely a short-timer in his current job, he emphasized the current extraordinarily accommodative monetary is likely to persist for some time. The labor market is significantly weaker than implied by the widely watched data, notably the official 7.6% unemployment rate. This number is misleading, as millions of people who have taken part time jobs really want a full time job are not considered unemployed. Also, there are a large number of people who have temporarily given up trying to find a job; these people are also not considered unemployed. However, many of these people are likely to return to the pool of unemployed as the outlook on new hiring improves. These factors make it very difficult for the “published” unemployment rate to move much lower for the foreseeable future.
James Bullard, President of the Federal Reserve Bank of Saint Louis, was in attendance this week and supported Bernanke’s position. They made note of the fact that inflation is running below its 2% target. Bullard dissented from the latest FOMC directive, contending the Fed should be symmetrical in preventing inflation from falling too low as it is vigilant about letting inflation rise too high. We agree with Bullard that pulling the plug on the stimulus too early could actually lead to a bigger economic challenge if the economy were to fall back into another recession. The risk has to be weighted in favor of aggressive action to produce economic growth even if inflation ticks up slightly from the current low rate, since it is currently below that 2% target.
Chairman Ben Bernanke’s term ends on January 31, 2014, and it is unlikely that he will be nominated for another term. During his remaining time he is likely to avoid any comments on tightening and will push hard to boost confidence that the economy is recovering. At this time we do not think the market will be hit with any additional short term fear of an imminent reversal in Fed policy during 2013, as Bernanke does not want to create “chaos” as he leaves office.
All told, between Bernanke’s comments, economic data, and corporate earnings, the market bounced back nicely this week. Today, the S&P 500 Index closed at 1,680.19, a new all-time high. Several of the underperforming asset classes such as energy, commodities and emerging markets rose nicely. Bank & financial stocks are getting a lot of positive analyst support as they are likely to benefit from better spreads as interest rates creep up. The key metric we are looking at for the banks is growth of business loans. Confidence is still shaky for businesses of all sizes and owners/CEOs have been reluctant to use the “cheap money” that is available for growth initiatives. We would also like to see merger & acquisition activity increase during the remainder of 2013 which would indicate a boost in CEO confidence.