SCOREBOARD: Fed frustration

Wall Street found disappointing wording in Ben Bernanke’s testimony, but his comments didn’t change the bank’s tune on QE.

Depending on which headline you want to read, Ben Bernanke’s comments last night either disappointed punters because they suggested QE could be reined in soon, or they suggested it wouldn’t. I would go with the latter.

Now, it is true that Bernanke said QE could be pulled in over the next few meetings. We can only hope that is true as it is long overdue. Also being quoted quite a lot was the section in the FOMC minutes that read, “Most observed that the outlook for the labor market had shown progress since the program was started in September” and that “A number of participants expressed willingness to adjust the flow of purchases downward as early as the June meeting if the economic information received by that time showed evidence of sufficiently strong and sustained growth”.

Fair enough then that from this you could assume a QE tapering may be imminent. This is the problem when the Fed uses vague, qualitative words like “substantial”. Policy hinges on it – yet what is it? This deliberate vagueness is not good for policy transparency.

Anyway, I’m not sure that the QE tapering signal was all that strong to be honest. For a start, Bernanke also said – and this was something consistent with the FOMC minutes released this morning and rhetoric from other Fed officials such as William Dudley et al – that “A premature tightening of monetary policy could lead interest rates to rise temporarily but would also carry a substantial risk of slowing or ending the economic recovery and causing inflation to fall further".

Moreover, while there was chatter about tapering QE at the FOMC, “many of these participants indicated that continued progress, more confidence in the outlook, or diminished downside risks would be required before slowing the pace of purchases would become appropriate” and “views differed about what evidence would be necessary and the likelihood of that outcome".

The other thing is that when you dig into the detail of what Bernanke and others are actually saying, you can see that they haven’t really changed their tune. That is, the language on key elements hasn’t really changed.

So Bernanke might have noted, belatedly, that “Conditions in the job market have shown some improvement recently…payroll employment has now expanded by about 6 million jobs since its low point, and the unemployment rate has fallen two-and-a-half percentage points since its peak.” Yet in the next breath he said that “Despite this improvement, the job market remains weak overall." The Fed has held this line all through the jobs surge and sharp pick-up in private sector activity.

Also of significance was the fact that nowhere when discussing the labour market – not anywhere in Bernanke’s testimony or the minutes – did anyone use the word "substantial". Recall that for QE to be reined in there needs to be a "substantial" improvement – whatever that is. Bernanke only notes that "progress" has been made.

The two other reasons that the Fed is divided are: “One participant preferred to begin decreasing the rate of purchases immediately, while another participant preferred to add more monetary accommodation at the current meeting,” and it’s quite clear that some Fed participants are using the recent and temporary drop in inflation as an excuse to become more dovish.

So the Fed notes that “Consumer price inflation has been low. The price index for personal consumption expenditures rose only 1 percent over the 12 months ending in March.” However, what is mentioned but completely glossed over is that inflation was “two-and-a-quarter per cent during the previous 12 months”. Although that in itself was important (inflation was two-and-a-quarter per cent last year, above target), and through it all, QE was expanded.

That kind of highlights the position the Fed has. And Janet Yellen has said it bluntly. Even if inflation lifts and the unemployment rate shows a substantial improvement, even then QE may not be reined in. Straight from the horse’s mouth.

Now in terms of market moves, stocks and commodities weakened (S&P500 down 0.8 per cent, Dow off 80 points and Nasdaq down 1.1 per cent) while bonds sold off (US 10-year yield up 12 bps to 2.02 per cent). About the only commodity to rise was copper, up 0.7 per cent, but gold fell $9 to $1368 and crude fell more than 2 per cent ($94.13).

The Australian dollar, having hit a low of 0.9668, now sits at 0.9700 – the lowest in about a year, and a level the unit has hit only five or six times over the last two years. Whether it’s sustained or not depends entirely on the Fed – what the Reserve Bank of Australia does is irrelevant.

Not much otherwise – US existing home sales rose 0.6 per cent in April after a 0.2 per cent fall.

Regarding those consumer confidence numbers, I think they pretty much prove – not that there could have been any serious doubt – that the Reserve Bank's easing cycle has (and is continuing to) weighed on confidence in this country. It’s not the sole reason of course, but it is playing a very important role.

Now, true to say that the 7 per cent fall was blamed by some economists on the government’s budget. To see why this doesn’t make sense, consider two things. Firstly, the budget itself was boring, and secondly, what was in the budget wasn’t new. There was nothing new in the budget that hadn’t been leaked well before. So for instance, that the government had failed to achieve a surplus was well flagged all the way back in December. That the Medicare levy would rise to fund the national disability insurance scheme was flagged in February – and in any case, I think most support the scheme.

So to argue that consumers are having a lagging reaction to preannounced news is like saying that consumers only reacted to rate cuts – one year later. And many economists did just that. It’s a tad insulting to consumers I think, and not something I think is even remotely credible. That’s not to say I think the budget was great – I don’t, but neither is it reasonable to think that the slump in confidence in May was based on old news.

Importantly, this is not the first time that confidence has slumped in reaction to the Reserve Bank's cuts, and you couldn’t even say that the bank was reacting to the fall in confidence. Confidence has fallen in response to the debate about needing rate cuts – -5 per cent in April and -7 per cent in May. In contrast, when it looked like the Reserve Bank would be on hold or we were about to see the end of the easing cycle, confidence surged. The great tragedy is that this is the cost of trying to target the exchange rate – confidence has been trashed!

Not much else tonight – US jobless claims, new home sales and house prices are the big ones.

Have a good one…

Adam Carr is a leading market economist.

Follow @AdamCarrEcon on Twitter.

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