Comstock Partners, Inc.July 11, 2013
The FOMC's Muddled Views
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 economy.
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.