Stock Market Remains Unstable as Fed Announces No New Stimulus Measures at Jackson Hole Conference on August 26

At the Federal Reserve conference in Jackson Hole, Wyo, on August 26, 2011, Chairman Ben Bernanke left open the possibility of more action by the Fed if another recession looks likely. But he announced no new economic stimulus measures during his speech at the conference. Indexes fell sharply as the speech was released and it became clear that Bernanke was not promising new stimulus measures. The Dow Jones industrial average was down about 78 points shortly before the speech started and slumped as many as 220 points shortly after Bernanke started speaking. It recovered those losses within an hour. By late morning major market indexes were all trading higher. Many traders were disappointed that the Fed chairman didn't offer steps to shore up the fragile economic recovery. Optimism had been building on Wall Street this week that Bernanke might announce some kind of action. Bernanke was speaking at a conference in Jackson Hole, Wyo., the same event where he announced plans for a bond-buying program a year ago. - Stocks recover after Bernanke predicts US growth, Associated Press, August 26, 2011

The Selling on Wall Street Isn't Even Close to Over Yet:

The Fed reiterated in June that the overnight interbank lending rate would be “exceptionally low” for an “extended period” and said the policy of reinvesting maturing securities to keep the balance sheet steady would be maintained, without saying how long. The “extended period” phrase means that the FOMC is at least two or three meetings away, or “significantly longer,” from taking any action, Bernanke said at a June press conference. Economists are divided on whether the Fed will act now, with 35 percent of 46 respondents saying the easing step would come today and 39 percent predicting a move at the next meeting Sept. 20. Fifteen percent saw a potential decision at the Nov. 1-2 meeting, and the remaining 11 percent said sometime after the Dec. 13 session. - Fed May Strengthen Stimulus Pledge on Renewed Recession Concern, Bloomberg, August 9, 2011

Fed's QE3 is the Drug the Market Craves

August 10, 2011

realclearmarkets.com - The expectation now is that Fed Chairman Ben Bernanke and the central bank will follow the same script as 2010. Last year, equities sold off sharply heading into summer as economic activity weakened. The Fed at first held off from promising more quantitative easing before Bernanke made a speech in Jackson Hole, Wyo., during the Fed's annual symposium. Investors now expect a sequel one year later, with Bernanke set to address the Fed conference Aug. 26.

"The announcement, if we get one, will come around Jackson Hole later this month," Roberts says. "The markets will respond much more favorably if they aren't anticipating it. The Fed left the markets wanting a little more Tuesday afternoon. It's exactly like last year."

The benefit of a third round of quantitative easing is questionable, which may help explain the plunge in equities Wednesday. Roberts notes that the market had a sigh of relief temporarily, but he argues there will be very little impact in terms of the economy. Instead, more quantitative easing will see a smaller impact on the markets.

"In March 2009, everyone was convinced the world was going to end, so QE1 had a very big effect on the financial markets," Roberts says. "The second round of QE gave us some growth in the market but very little economic recovery at all. Each successive round of QE is having a law of diminishing return effect. You're getting less and less effect for every dollar of QE that's used. Eventually, QE will have no effect at all."

Dearborn's Nolte agrees and takes the analogy of quantitative easing as a drug further by noting the painful withdrawals that the market suffers after quantitative easing programs end.

"QE1 and QE2 were artificial. When they come off -- ultimately it has to come off -- then you wind up with the pain that we're suffering with now and what we suffered with last year," he says.

Nolte adds that the quantitative-easing measures to date and any future programs will ultimately be ineffective because the Fed is not in a position where it can address the real problems of the economy.

"The QE process has not translated to better economic results because it's not fixing the problem that we have," Nolte says. "The Fed is injecting more into the banking system, not the economy. The overarching issue, both here and in Europe, is debt. The Fed can't do a damn thing about that. It has to come from the political side, and there is no will to address that."

Diane Swonk, chief economist with Mesirow Financial in Chicago, offers her own analogy for the quantitative-easing measures.

"You could throw money out of a helicopter, but if it gets stuck in the trees and people can't pick it up, they can't spend it," she says. "It's the private sector that has failed to step up to the plate as government spending has faltered."

"It's back to reality. And reality sucks, but it's exactly what we need," says Michael Pento, senior economist with Euro Pacific Capital. "Bernanke was correct that oil prices and inflation were going to be transitory. But what has proved to also be transitory is economic growth and gains in the stock market."

Pento argues that the U.S. never actually emerged from a recession and that the negative growth was only masked by inflating the consumption bubble.

"You can only juggle that for a limited period of time," he says. "We have an economy that was and still is mired in debt. We have a debt-to-GDP ratio at 92%, double what was in the 1980s. The only thing that happens when you have an overleveraged economy, you need a period of deflation and deleveraging. It's very painful and it causes asset prices and GDP to plummet, but that's part of the healing process to bring things back into balance."

Last Year at Jackson Hole Inflation Was Rapidly Decelerating So the Fed Laid the Groundwork for QE2, But the Opposite is True at Present So Don't Expect Big Moves Like QE3 This Year

August 21, 2011

Reuters - While it's not time for emergency measures, the patient still needs the drip.

The U.S. economy is grinding so painfully and haltingly toward recovery that the Federal Reserve looks poised to incrementally strengthen the dosage to keep growth on track.

Expect Fed Chairman Ben Bernanke to use a speech at an annual central bank conference in Jackson Hole, Wyoming, next Friday to acknowledge his disappointment over the pace of growth, even downgrade his outlook, and explain which medicines left in the Fed's cabinet are best suited to fortify the economy.

He looks unlikely to reach for shock treatment.

"With the recovery grinding to a halt in the first half of this year and the economy operating perilously close to a second recession, the Fed will remain on guard against a negative surprise on growth, and will be willing to act accordingly," Millan Mulraine, an economist with TD Securities, wrote in a note to clients.

So, how is Fed to administer further remedies?

With interest rate tools well exploited, Bernanke is most likely to focus on the Fed's balance sheet and opt for tinkering with the size and composition of its portfolio to get the world's largest economy out of its funk.

Interest rates are already near zero, and the central bank's policy-setting Federal Open Market Committee just two weeks ago signaled it is willing to hold borrowing costs at rock bottom levels for two years if necessary. There is little more that can be achieved using the rates tool.

Many of the balance sheet steps are well known, and each carries its own risks and rewards, which Fed staff would research carefully. But chances for a major new bond buying operation announced at Jackson Hole would appear limited currently.

In shaping its thinking, the Fed is likely guided by a sense that the current situation, though rather uncertain, merits a cautious approach and does not arise to the crisis proportions seen in 2008 through 2010 that justified bold and aggressive moves.

The last of these - the $600 billion bond purchase program dubbed QE2 because it was the second installment of quantitative easing - was the Fed's response to historically low inflation that risked tipping the U.S. economy into a vicious cycle of falling prices and falling consumption and investment.

The situation today is different.

Unlike mid-2010, U.S. inflation is now higher, and core inflation, which strips out volatile food and energy prices has accelerated. While higher readings are a concern for some Fed officials, they are not raising widespread alarm at the central bank on the assumption that overall inflation will fall as energy prices recede and that core prices will remain in check.

Instead, the focus is on stumbling growth and the risks ahead. A central group of policymakers on the Fed's decision-making committee see mounting evidence that growth originally forecasts at around 3 percent for the second half of the year will be slower. While not as dismal as the 1 percent that some Wall Street firms are forecasting, growth this sluggish would fall well short of what's needed to reduce the steep 9.1 percent jobless rate.

Looming large as a risk factor is Europe's long running sovereign debt saga, which is pummeling U.S. financial markets and business confidence. So far Europe's woes and the market turmoil have not caused distress on the scale of the 2008/2009 credit crisis, but it is worrisome.

NO BIG GUNS

Against that backdrop, Bernanke appears unlikely to reach for dramatic measures, but the Fed could be primed to gradually boost the dosage for the ailing economy over the coming months.

One initial step might be simply to use verbal communication. It could commit to maintain its balance sheet, which has ballooned to $2.8 trillion from a pre-crisis level of around $900 billion, at this high level for an extended period of time -- even adding a timeframe just as it has for the fed funds rate.

Another measure would be to put downward pressure on medium to long-term interest rates, where mortgages are fixed and corporations borrow, by taking steps to weight the mix of assets in the Fed's balance sheet toward longer-maturity instruments. This can be done either by replacing its maturing securities with longer-term ones, or by actively exchanging shorter maturities with longer ones.

"Last year at Jackson Hole when the Chairman laid the groundwork for QE2, inflation was rapidly decelerating -- the opposite is true at present," Deutsche Bank economist Carl Riccadonna wrote to clients.

"As a result, if the Fed does move toward additional accommodation, it may first try to extend the average maturity of its portfolio rather than further expand its asset holdings."

A bolder step would be to buy more bonds, though conditions do not seem to merit that at this juncture. While Fed officials argue bond buying has held longer term rates lower than they would otherwise have been and moved investors to seek riskier assets than safe-haven Treasury securities, the strategy has drawn sharp criticism domestically and internationally.

As a way to tamp down worries that bond buying would spur inflation, the Fed could consider sterilizing new bond buying by simultaneously draining bank reserves. Doing so would remove risk and duration from credit markets, push down interest rates at the longer end of the yield curve, while keeping abundant reserves in check.

FACING THE CRITICS

U.S. critics charge that fresh measures would court inflation. Detractors abroad say bond buying drives down the dollar, drives up commodity prices and unleashes volatile investment flows into emerging markets. Even some within the Fed object to aggressive easing, and the Fed's August low rate pledge drew an unusual three dissents.

The Fed faces domestic political attacks as well. Republican presidential candidate Rick Perry this week said any further Fed monetary easing would be "almost treacherous, treasonous.

But the Fed has a track record of political independence and its credibility stems from a reputation of being free to act regardless of the political winds. To bow to these critics when the economy needed further support would be unusual.

Bernanke has a chance to make his case on Friday.

Flashback: Dislocations Ahead: The Ratchet Effect, Stick-Slip and QE3

The Fed has galloped into a box canyon with no escape; no matter what it does, QE3 will "disappoint" the markets.

February 14, 2011

oftwominds.com - I think we can safely predict that "Quantitative Easing 3" (the next round of fiat money creation) will "disappoint," triggering stock and bond market mayhem. Last week I noted that the U.S. economy is now addicted via the ratchet effect to unprecedented levels of Federal borrowing and Federal Reserve fiat/credit creation and manipulation.

In other words, the status quo is now completely dependent on the Federal government borrowing 40% of its expenditures ($1.5 trillion a year) and on the Federal Reserve printing fiat money and buying $1 trillion in Treasury bonds every year.

Now that Central State spending and intervention have ratcheted up to those levels, any reduction will destabilize the staus quo of zero-interest rates (ZIRP), unhindered entitlement and military/Security State spending, etc.

Thus we have politicos proposing $35 billion in "cuts" to a Federal budget ( $3.8 trillion for fiscal 2011) which has leaped up by hundreds of billions of dollars in a mere decade.

Two other concepts which I have been discussing in my "weekly musings" (also covered in the Survival+ critique) may apply here as well:

1. Stick-slip phenomena, which I have previously suggested may shed conceptual light on the housing market's phase shifts.

An earthquake is an example of this phenomenon: the pressure on two adjacent plates of the Earth's crust rises without apparent consequence until the plates suddenly "slip," triggering a devastating earthquake.

2. Punctuated equilibrium, a concept from evolutionary biology based on the observation that the stasis (stability, equilibrium) which dominates the history of most fossil species is disrupted (punctuated) by short periods of rapid evolution.

Systemic change--rapid changes in climate and ecology--pressure organisms which had adapted to other circumstances to either experiment (via mutations) and evolve to suit the new environment or go extinct.

The stock and bond markets now depend on massive injections of free money (via the Fed's POMO) into equities and the purchase of newly minted Treasury bonds. This is the ratchet effect on a large scale: any attempt to ratchet down the Fed's interventions will cause uncertainty and doubt about the consequences, for no one seriously believes that private demand is just aching to jump in and replace the Fed's trillion-dollar buying sprees in stocks, bonds and mortgages.

Beneath the surface of illusory stability, pressures are mounting. A stock market which is now entirely reliant on monthly injections of $100 billion of "free money" from the Fed's "quantitative easing 2" program is a market that is exquisitely vulnerable to any reduction in that stimulus.

The same can be said of the bond market, which globally is groaning under the demands of sovereign states borrowing trillions of dollars annually in new bonds from now until Doomsday (roughly 2021, last time we looked, though many see 2012 as the end-game).

If the Fed stops buying Treasuries, then rates--already rising on the long end--will move decisively higher, bollixing the Central State's entire game plan of rescuing the insolvent banks and goosing a "recovery" with low interest rates and unlimited liquidity.

The Fed and Treasury are now boxed in by the ratchet effect. Any reduction in the Fed's unprecedented intervention, no matter how modest, will trigger an earthquake of uncertainty: the apparently "sticky" stability will slip in a dislocation.

The problem with expectations is also a reflection of the ratchet effect: they only go up.

Rather than adapt and evolve, the Central State and its proxy the Federal Reserve simply moved into a higher state of vulnerability. The global financial crisis which finally broke through all the Central State defenses in 2008 punctuated the illusory stasis/stability of the financial status quo. The opportunity to evolve was tossed aside in favor of extend and pretend, denial, and the transfer of risk and liabilities from the now-insolvent parasitic financial Elites to the taxpayers (profits were private, losses are now public).

In effect, the Fed moved into an even more precarious ecosystem, in which the "free markets" of stocks and bonds are now totally dependent on massive Fed manipulation to maintain their current stability. Yet the levels of Fed intervention are so enormous that they are inherently unstable. the illusory stability of the present has been purchased by increasing the systemic levels of instability.

Add these factors up and predicting the Fed's next round of "Quantitative Easing" (QE3) will "disappoint" expectations is easy. The reason is straightforward: the only way the Fed can avoid disappointing lofty expectations is to ratchet up its fiat creation/market manipulations another tooth. Even keeping QE3 the same size as QE2 will "disappoint" those who fear it isn't enough to "stimulate self-sustaining growth" (i.e., an economy which doesn't depend on borrowing 11% of GDP every year and the monetiziation of 2/3 of all new Federal debt via Fed purchases).

Political resistance to the Fed's headlong gallop into the box canyon of monetization and stock market manipulation is rising. The Fed's policies have enriched the top 10%--those who directly own enough stocks to experience a "wealth effect"--and enabled Wall Street to gorge on "free money profits" unleashed by the Fed's diversion of national income to the banks via zero interest rates. But politicos are increasingly aware that the Fed's lifeboats have only saved these Elites, while the passengers in steerage--the bottom 80%--are watching the Titanic sink lower in the water from the tilting deck.

The Fed is boxed in: by expectations of continued massive intervention and by political pressure to cease or curtail these very same interventions.

Ironically, if the Fed flouts political pressure and ramps up its manipulations via a monumental QE3 program, that may well disrupt the markets as much as a policy of diminished intervention, for the markets would soon grasp that the Fed would be guaranteeing a political firestorm of resistance if the Fed's manipulations didn't spark a hiring/jobs boom by the 2012 election season.

And we all know the Fed's QE3 will not spark a hiring boom, for the Fed's policies are designed to serve one goal: preserve and enrich the financial sector's Elites. Now that they're safely in the lifeboats, the failure of the Fed's policies to "trickle down" to the steerage passengers is increasingly evident.

Recapitalizing the "too big to fail" banks has not yet been accomplished, despite the Fed's gargantuan channeling of national income into Wall Street and the TBTF banks. So the Fed is triply boxed in: its unprecedented efforts to recapitalize the TBTF banks and restore Wall Street's swollen profits are only partially complete, yet it is already encountering stiff political resistance.

Even worse, the interventions have had to be ratcheted up to maintain their effect, akin to an addiction or insulin resistance. The vulnerabilities have not been erased, they've only been masked. The pressures on the financial faults beneath our feet are increasing, and the tremors will soon give way to sudden dislocations of expectations, risk and price.

More ‘Shock-and-Awe’ Fed Easing? We’ve Seen this Movie Before

August 11, 2011

BigGovernment.com - Ben Bernanke’s shocking FOMC announcement on Tuesday — that its zero-interest-rate target would be extended for two more years through the middle of 2013 — drove Dow stocks up over 400 points. But this new policy had no stock market carry-over on Wednesday, when the Dow plunged over 500 points.

But we have not heard the last from Ben Bernanke — not by a long shot.

Buried in the last paragraph of this week’s surprise FOMC announcement was this huge statement:

“The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability.”

This is a brand-new statement. And in all likelihood it was purposefully open-ended. A Fed source suggests that this sort of stuff is usually left out of sight and buried in Fed committee minutes, released well after the FOMC meeting, and not put boldly in the actual policy statement. So clearly, it’s very important.

What might it mean?

When Bernanke speaks at the Fed’s Jackson Hole, Wyoming, meeting on August 26, he could conceivably launch a real shock-and-awe stimulus program. If you go back a year, when Bernanke first announced QE2 at Jackson Hole, sources tell me that the original debate over the quantity of bond purchases had a $2 trillion balance-sheet expansion on the table. Inflation hawks beat that number back to $600 billion. But now the rest of that $2 trillion — or $1.4 trillion — could conceivably be on the table for a new QE3 announcement by the Fed.

A new round of Fed bond purchases would likely be aimed at pinning long-term interest rates down as much as possible. In other words, the Fed will be buying 10-year paper and maybe even 30-year paper to get those yields down even more (10-years are currently around 2 percent). The idea would be to reduce the attractiveness of government bonds and get investors into riskier assets like stocks, or perhaps even new-business and venture-capital start-ups where potential yields look even more attractive. There may even be some job-creation in all this.

Plus, the Fed’s potential Jackson Hole shock-and-awe program could include the removal of the 25-basis-point Fed payment on the $1.6 trillion excess bank reserve now on deposit at the central bank. If the banks no longer earn a safe 25 basis points, they might conceivably lend more.

And if long-term rates come down as per Bernanke’s target bond purchases, mortgage rates might come down even more to the benefit of future and current homeowners.

Politically, inside the Fed, three regional bank presidents dissented from the unprecedented Fed decision to keep its target rate down for two more years. But the inner circle of Fed power — Ben Bernanke, Janet Yellen, and William Dudley — has enough votes from other Fed board governors and reserve-bank presidents to jam through almost any shock-an-awe it wants. All this could be announced formally at the next Fed meeting on September 20, but Bernanke himself is likely to let the cat out of the bag in Jackson Hole toward the end of this month.

The trouble with all this is that it didn’t work the last time with QE2, and it will have no permanent effect on the slumping economy. Targeting bond yields and printing more money simply distorts asset prices throughout the financial markets. We’ve seen this movie before. And it didn’t play well. The Fed’s shock-and-awe risks another round of dollar depreciation. It’s part of the message of skyrocketing gold prices right now.

Unleashing dormant animal spirits in this economy can only come from the fiscal side, with low-tax and regulatory reforms to provide new economic-growth incentives and lower the cost of doing business. A pro-growth package from Washington is what we really need. It should be part of the next round of budget cuts, included in the work of the super committee during phase two of the debt deal.

Without those new incentives for growth, the Fed can print all the new money in the world and the federal government can spend itself into oblivion, and none of it will resurrect the economy.