Michael Santoli

Fiscal Flap Vindicates the Fed’s Easy-Money Call

Michael Santoli

Who out there still thinks the Federal Reserve blew it last month by leaving its stimulus program unchanged? Where are the vociferous critics of Fed Chairman Ben Bernanke, who loudly blamed him for botching his message and defying market expectations that the Fed would “taper” its monthly pace of bond purchases from the current $85 billion pace?

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Even though the Wall Street consensus quickly rushed to insist Bernanke had missed a fine opportunity to get on with the exit from quantitative easing, pretty much everything that has happened since the Fed’s policy statement sparked a stock selloff and a rally in Treasury securities has vindicated the “non-taper” call.

The Federal Open Market Committee's formal statement cited “the extent of fiscal retrenchment” as a factor in its evaluation of the economy’s performance and prospects. Bernanke, in his press conference, repeatedly, if politely, chided Congress for its inability to strike a budget deal and its knack for holding the government-debt ceiling hostage.

Sure enough, we now have a federal shutdown with 800,000 workers sidelined without pay, only halting progress on negotiating a “continuing resolution” to fund the government and the prospect that the debt ceiling might not be raised in a timely way.

Atlanta Fed President Dennis Lockhart this week explicitly said the shutdown and related effects vindicate the central bank’s stand-pat decision.

"I would say that events like the government shutdown, or conceivably a debt ceiling debate that undermines confidence, has a lasting effect in that it makes our economy look more prone to politically induced shocks,” he said.

Bernanke suggested last month that the economy, and especially the housing market, had not been sufficiently stress-tested for long enough by somewhat higher mortgage rates that had taken hold since the spring. And as it happens, mortgage applications have flattened out, especially for new home purchases, and the S&P Case-Shiller home price index has leveled off.

In the past month, given the Fed’s non-taper and anxiety over the fiscal impasse, 10-year Treasury yields have dipped to 2.65% from 2.98%, which should help refresh housing demand at least slightly.

Eye on Main Street

The Fed voiced some concern that the job market, while improving, was not as strong as the declines in the unemployment rate suggested, given the declines in the number of people in the active labor force looking for work. This week, the ADP private-payrolls number for September came in a bit below forecasts and August numbers were revised a bit lower.

There was no official employment report due to the government closure, but there are few signs that job creation surged in recent weeks. Meantime, the Gallup daily U.S. Economic Confidence Index recently sagged to a 14-month low, no doubt dragged lower by the exasperating D.C. budget drama.

None of this means the economy is deteriorating badly, or won’t pick up up soon. Indeed, the corporate and industrial sectors -- the parts of the economy that have been thriving -- continue to send encouraging signs. The ISM Manufacturing Index for September, released Tuesday, rose to its highest level since early 2011, indicating a broad quickening of factory activity. Corporate profits, while flattening out, remain at historic highs and should soon show decent growth over tepid fourth-quarter 2012 levels.

Yet the Fed’s long-emphasized attention to the full spectrum of incoming economic data still presents a mixed picture, one that didn’t rise to the threshold making a “taper” a no-brainer, and very well might fall short come the October Fed meeting. The dearth of official data and Washington trench warfare also fall on the “no change” side of the scale Bernanke is using to manage QE.

Of course, despite the market pullback on D.C. headlines and questions over the economy’s oomph, conditions remain broadly supportive of stock values as they have been for the past 11 months or so -- slow but consistent growth and lots of financial liquidity.

Michael Hartnett, global strategist at Bank of America Merrill Lynch, sums up the environment like this: “We believe the largesse of central banks (max liquidity) and selfishness of corporations (max profits) is max bullish for Wall Street, albeit much less bullish for Main Street.”

Never mind the common japes that Bernanke cares only for financial markets and seeks to inflate asset values alone. His mission is to set the conditions to help Main Street heal economically, and as long as the real economy seems to be underperforming its potential, it will keep him erring on the side of more, rather than less, easy-money efforts.

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