By Terry Connelly
When Federal Reserve Chairman Ben Bernanke testified before the Joint Economic Committee of Congress on May 22, he noted in his testimony that an unanticipated (premature) tightening of the Fed’s monetary policy would probably entail a “major market correction.” While the Chairman was most probably using the term “tightening” with reference to a change of direction in its low short term interest rate policy of .25 percent (clearly set in place until unemployment hits 6.5 percent), he wound up triggering the possible onset of just such a correction (if not just yet in the US, at least in Japan and other Asian stock markets) with some other things he had to say about the Fed’s other stimulus policy – the monthly $85 billion purchases of treasury and mortgage securities known as QE III.
But the Chairman can hardly be blamed for not anticipating just how many commentators would twist his words into a veritable prediction of an imminent “tapering” of such purchases – something the markets had not heretofore been expecting until late this year at the earliest given the fragile and uneven state of the US economic recovery.
What Bernanke actually said about QE, in response to a loaded question from a Congressman about whether the Fed would in fact reduce the amount of bond buying by Labor Day, was that the Fed “could” look at doing so but with a big proviso which he summed up as depending upon “sustainable improvements” in the labor market (which his prepared remarks had specifically characterized as showing “some improvements recently” but remaining “weak overall”). Indeed, he had also already stated that “withdrawing policy accommodation at this juncture would be highly unlikely” to produce economic conditions supporting higher interest rates. Yet higher interest rates are just what we are getting as a string of commentators have reinterpreted the Chairman’s Q&A response from its actual character as a highly conditional possibility into something entirely different.
Even the famous “Fed whisperer” John Hilsenrath, in a feature article in the Monday June 10 Wall Street Journal literally changed the plain English meaning of Bernanke’s words by restating his condition (without quotes, of course) for a QE “step down in the next few months” as not “sustainable improvement” in the economy but rather “as long as the economy doesn’t disappoint.” With this kind of word twisting going on at the hands of a highly respected reporter and business journal, it’s no wonder that the US equity market reacted with three straight days of downward trajectory, Japan fell into correction territory and the Honk Kong market opened severely down after a three day holiday.
We have noted before that the hedge funds that missed the first quarter rally in US stocks because they were too focused on proving their ideology that markets can’t go up under Obama, had been trying (unsuccessfully) to talk down the markets with talk of a repeat of the past several years’ early spring “swoons” brought on by fears (proved unfounded) of a euro collapse, Greek default, German withdrawal from the euro and a US debt default. They tried this time to turn little Cyprus into a “sky is falling crisis.” When that didn’t work, they said the sequester was a market doomsday machine. That didn’t work.
Finally, they tried to roast the old chestnut, “sell in May and go away.” That didn’t work either, until the very last day in May, when the “reinterpretation” of Bernanke’s remarks began to pick up steam and other Fed governors (but not necessarily voting Committee members this year) began to repeat their arguments for a reduction in QE as early as June. This wasn’t news, but it fed the gathering impression that Bernanke’s remarks might have been a “trial balloon” to see just how the markets might all if the Fed actually did pull the trigger on tapering this summer. Then Hilsenrath sealed the deal with his re-write of the Bernanke testimony, leveraged by his reputation as a Bernanke insider, and we get the first three straight down days in the Dow and S&P in 2013.
Thus the hedge funds finally begin to get what they have wanted for several months now – a flight from winning stocks on the part of investors who now have doubts that Bernanke has their back (while the hedge funds know full well that what Bernanke actually said spells no cuts to QE before the snow flies).
Fed “participants” Plosser and Fisher – who both purported wrongly to speak for the Fed as a whole in terms of reversing course on QE – aren’t even voting members this year. Kansas City Fed bank President Esther George is a voter but a known dissenter on QE in the first place. So where’s the new consensus on cutting back QE? Can’t find it in the latest Fed minutes, which note disagreement as even what the standards would be for measuring the economic performance what would justify reducing bond purchases! Can’t find it in Bernanke’s testimony, unless you turn a hypothetical into a hypothesis, or just turn his actual statement upside down, a la Hilsenrath.
But meanwhile “jitters” have spread globally that the Fed is about to lead the global cast of central banks into withdrawing stimulus, and just at the wrong time. Come on, does this sound like the Ben Bernanke we have come to know? There a lot of folks who will be using their nano-second trading advantages in the middle of next week to scoop up all the shares knocked back by these jitters just in advance of the Fed’s actual decision and post meeting statement and most importantly Bernanke’s post-meeting press conference and the accompanying update of the Fed’s forecasts for the economy going forward.
Remember that Bernanke and the Fed, in their previous official policy in his previous policy pronouncements, have always focused issue of QE duration on sustainable improvement in the “outlook” for employment and inflation rates. Unless that “outlook” as evidenced in the Fed’s aggregated forecasts for the economy over the coming quarters turns decided up, don’t look for QE to tune decidedly down!
Terry Connelly is an economic expert and dean emeritus of the Ageno School of Business at Golden Gate University in San Francisco. Terry holds a law degree from NYU School of Law and his professional history includes positions with Ernst & Young Australia, the Queensland University of Technology Graduate School of Business, New York law firm Cravath, Swaine & Moore, global chief of staff at Salomon Brothers investment banking firm and global head of investment banking at Cowen & Company. In conjunction with Golden Gate University President Dan Angel, Terry co-authored Riptide: The New Normal In Higher Education.