Although at first glance Chairman Bernanke's press conference consisted of the usual "boiler plate" Fedspeak, a more attentive examination leads to a number of disturbing conclusions that support our negative stance on the economy and stock market. Our observations are as follows.
1) The Chairman confirmed, as expected, that QE2 would continue until its conclusion at the end of June and would not be extended. He then stated that there would be no tightening of monetary policy until it was clear that the economic recovery was self-sustaining and strong enough to lower unemployment. However, his definition of initial tightening was an actual drawdown in the Fed's balance sheet. He said that he did not regard the ending QE2 as a tightening since the Fed's balance sheet would remain at the same level. To us, this is quibbling over semantics. The fact is that since November the Fed has been expanding its balance sheet at an average of $3.8 billion every day of working week and this will come to a sudden halt. Call it whatever you will, but there's no denying that this is a big difference.
2) When asked why the Fed wasn't doing more to create jobs, the Chairman spoke about a "tradeoff" between further stimulation and inflation. He was in effect stating that more easing of monetary policy was highly unlikely, meaning the unemployment would remain uncomfortably high. Since short-term interest rates can't get any lower and additional quantitative easing is off the table, it seems to us that monetary policy gets a lot less easier by the end of June.
3) When asked about Professor Rogoff's book showing that recessions following credit crises are always far deeper and longer than garden-variety recessions, Bernanke suggested that perhaps previous monetary authorities had not done enough to stimulate recoveries. However, with additional stimulation virtually being ruled out and the economic recovery still fragile, the question arises as to how this time will be any different.
4) Another questioner, expressing some doubts about the effectiveness of QE2, asked what proof Bernanke had that the policy was really working. In answering, the Chairman pointed to the higher stock market as his proof, confirming that the Fed's actual policy was to goose the stock market in the hopes that the increased wealth would spread to the economy. However, housing prices, which are much more important, are continuing to drop, and stock market gains alone do not have a high correlation with increased spending.
5) It is also illogical that while claiming credit for rising stock prices, the Chairman denied that Fed policy had anything to do with rising commodity prices. The $600 billion of proceeds from QE2 went to the sellers of the Treasuries, who were then free to invest in financial instruments of their own choosing. It's a real stretch to assume this all went to stocks and not to alternatives such as commodities.
6) Although the Chairman showed an obvious tendency to call most negative factors "transitory" (a word that popped up often), he assumed the economic positives were real. He did concede, however, that unemployment, high gasoline prices and rising mortgage foreclosure rates were real problems. Unfortunately, however, he couldn't do anything more about unemployment because of the aforesaid inflation tradeoff while higher gasoline prices and mortgage foreclosures were beyond the Fed's control. So we are left with the conclusion that the Fed is powerless to do anything about three major factors creating strong headwinds against growth in consumer spending.
In sum, the press conference only served to confirm our conviction that the economic recovery cannot stand on its own and that monetary policy is about to become less easy at a time when additional fiscal stimulus is off the table. As we have often pointed out, the aftermath of a credit crisis results in an overhang of highly excessive debt, weak recoveries, numerous recessions and many years to work out. Monetary and fiscal policy can help smooth the extremes but cannot halt the process.