The Bernanke Rally?

Bravo Bernanke for telling the screaming markets to go to bed without their supper.

There can be no justification for QE3 at a time when core inflation is creeping up to 2pc.

Nor when the M2 money supply is growing at 10pc, or M1 growing at 20pc, or credit is at last returning from the dead and turning positive again. Credit has accelerated to an 8pc annual compound growth rate over the last three months. And remember, Bernanke is a “creditist”. Lending is his lodestar.

Quite why markets seemed so assured that he would intervene to prop up Wall Street is beyond me. It shows how deranged this game has become.

Bernanke looks at fundamentals, which include the wealth effects of Wall Street as just one variable. His real enemy is deflation and the Japan syndrome, though he has been remarkably bad at articulating this.

As he said in Jackson Hole, the economy is very slowing healing itself in spite of fiscal tightening (some might even say because of it). Indeed it is. US corporations are sitting on $2 trillion. Households are chipping away at their debts (admittedly by defaulting on mortgages in many cases, but that too is debt clearance).

I have a hunch that Bernanke’s first hints of cautious optimism may prove better rocket fuel for a durable rally than the Fed’s body-language of despair, whatever the markets say over coming days.

Nobel laureate Edmund Phelps advised the Fed should keep its “finger on the trigger” just in case the deflation threat returns, or Euroland blows up, or the world takes another nasty turn.

Europe may indeed blow up. The German constitutional court will rule on Sept 7 on the legality of the EU bail-outs, and that might be a moment to fasten your seatbelts.

What is ever clearer to me after spending a few days in Germany again is that the Bundestag is in no mood to increase the EFSF rescue fund by one pfennig beyond €440bn, let alone contemplate the €2 trillion figure deemed necessary by City banks. Which means Italy and Spain will be left to their fate once the ECB’s bond buying hits the limit (October?).

But the Fed cannot set policy on the basis of EMU contingencies. It sets policy for America, and America is not as sick as it looks.

The Fed Splits

FLOYD NORRIS

Notions on high and low finance.

There is more than meets the eye to the split at the Federal Reserve. There must be.

Notions on high and low finance.

The Fed’s statement Tuesday afternoon says that the majority “currently anticipates that economic conditions — including low rates of resource utilization and a subdued outlook for inflation over the medium run — are likely to warrant exceptionally low levels for the federal funds rate at least through mid-2013.”

Three dissenters said that they “would have preferred to continue to describe economic conditions as likely to warrant exceptionally low levels for the federal funds rate for an extended period.”

Now there’s something to fight over. I say we need low rates “at least through mid-2013.” You say “an extended period.”

All this sounds like much ado about very little, but the Fed majority is all but promising that rates will stay low for nearly two years. We used to think “an extended period” could mean a few months.

In reality, the statement was an implicit invitation to traders to drive rates down further on the two-year Treasury note, and that happened immediately. Before the announcement the two-year rate was around 0.27 percent. Now it is 0.19 percent. That is a record low. Two weeks ago it was over 0.4 percent.

The initial stock market reaction was negative, presumably because there was some hope that the Fed would do more — like start another quantitative easing program, QE3. Instead there is a promise that the Fed “will maintain its existing policy of reinvesting principal payments from its securities holdings. The committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.”

In other words, they might do a QE3. Or they might not.

Perhaps the dissenters really want to essentially say something like “We’ve done all we can, and if the economy is still lousy, that is for someone else to deal with.” And the majority is unwilling to do that.

As it is, the Fed has signed on to the widespread perception that the economy is getting worse. But it is not doing a whole lot.

The fact that the Fed chairman, Ben S. Bernanke, now has three dissenters is a sign that the Fed, like one or two other Washington institutions you might be able to name, is less and less able to speak with one voice.

Fed mixes it up and comes up with the worst of all worlds

Ben Bernanke, chairman of the US Federal Reserve, was able to deliver something to turmoil wracked markets; he promised to keep the fed funds rate close to zero until mid-2013, the first time, as far as I am aware, that the Fed has ever pledged to hold rates for such a long, and specific, length of time.

To commit to hold rates at virtually zero for nearly two years is unprecedented, and a mark of just how concerned policymakers have become at the economy’s inability to lift itself out of its funk. It provides markets and business with a degree of certainty on rates that they’ve never had before, and may therefore lift confidence.

But was it enough? The fact that three members of the open markets committee (FOMC) dissented from this promise maintains a strong, hawkish voice on the FOMC that undoubtedly remains fiercely opposed to any further quantitative easing. QE3 was the only thing that would comprehensively have reversed the current market rout, but Mr Bernanke cannot, for the moment at least, deliver it. Undue caution from the Fed combined with continued political paralysis on Capitol Hill does not make for a happy economy.

What committing to two years of zero interest rate policy will certainly do, on the other hand, is further weaken the dollar. Does the Fed know something the rest of us don’t to have taken such an aggressive position on rates. And what does it do if inflation returns? The Chinese, with inflation already at 6.5pc, will be spitting tacks. The Fed has mixed it up and come to a messy compromise which is neither one thing or the other. This was not what we hoped for.