Although the stock market has responded in a highly
positive way to Bernanke’s statement of Fed policy, little has really changed,
and the effects are likely to be temporary.
What set the market on fire was the Chairman’s statement that “a highly
accommodative Fed policy for the foreseeable future is what is needed for the
U.S. economy.” As we explain below,
however, this declaration, when examined closely, is essentially a reiteration
of what he has previously stated.
Bernanke has always maintained that a reduction of the
amount of Fed bond buying did not constitute a tightening of policy since they would
still be adding to the Fed’s balance and that this was stimulative despite the reduction.
He had also emphasized previously that the bond buying program and the fed
funds rate policy were not the same and that the fed funds rate would continue
to be kept near zero indefinitely, or as long as needed. The Chairman’s current statement did not
alter these views. He merely stated that
policy would remain highly accommodative, basically repeating his previous
views. The important point is that
nowhere in his speech or answers did he retract his previous view that tapering
of the bond buying program could occur later in the year, which is what spooked
the market earlier.
That Bernanke chose at this time to emphasize a different
aspect of the Fed’s policy is no surprise.
As we stated in prior comments, he was probably shocked by the bond
market’s initial negative reaction to a second half pullback in bond purchases
that threatened to reverse everything he’s been trying to do over the past
three years. Both he and other Fed
members gave a series of speeches over the last few weeks that failed to stem
the tide until yesterday’s statement.
Even then, long-term Treasury yields only declined by a small fraction
of their sudden rise, thereby threatening the ongoing housing recovery.
Furthermore, the FOMC minutes of their last meeting, released
a few hours before Bernanke’s speech, gave a much more muddled picture of the
members’ thinking. In attempting to
summarize the differing opinions of various Fed members, the summary used
qualifiers such as “one member”, “two members”, “another member”, “a few
members”, “a couple of members”, “several members”, “some members”, “many
members”, and “most members”. In sum, it is apparent that there is an unusual
lack of agreement among the various members about future policy.
In our view, the economy remains too sluggish to reduce
the bond buying program anytime soon.
GDP was up only 1.8% in the first quarter and looks even weaker in the
second. With release of the latest
wholesale inventory numbers, many economists have reduced their second quarter
growth rate to 1% or below. In addition,
the wheels seem to be coming off the economies of Southern Europe, increasing
the likelihood of another imminent debt crisis.
Chinese exports, the key driver of the economy, dropped 3% from a year
earlier, the first negative reading since November 2009. The decline reflected lower exports to the
U.S., Europe and Japan. Despite the decline,
Premier Li stated that he would not stimulate, and would emphasize long-term
structural changes, indicating that he may allow short-term softness in the
In sum, we think that the reduction in the Fed’s
bond-buying program will come later rather than sooner. But contrary to current market opinion, we
think this will be highly negative for stocks as it means a disappointing U.S.
and global economy and sharp downward revisions in earnings estimates.