Monday, June 4, 2012

Time for the Draghi and Bernanke Puts?

This week is an important week for investors who are watching for central bank action in the wake of market angst over Europe and the American economy. On Wednesday, the ECB will announce its interest rate decision and Mario Draghi will hold the customary press conference afterwards. On Thursday, Ben Bernanke will be testifying before Congress.

What will they say?

Don't expect too much
While I do expect that the ECB and Federal Reserve will intervene eventually, I do think that the markets may be getting ahead of themselves in anticipating another round of LTRO from the ECB or QE from the Fed. After all, Mario Draghi said last week that the ECB was reaching the limits of what it could do and it's now up to the politicians:
Draghi told a European Parliament committee in Brussels that without more aggressive action by policy makers the euro “is being shown now to be unsustainable unless further steps are being undertaken.”

He said it wasn’t his job to make up for the failures of policy makers. “It’s not our duty, it’s not in our mandate” to “fill the vacuum left by the lack of action by national governments on the fiscal front,” on “the structural front, and on the governance front,” he said.
The ECB is likely to reduce interest rates in the face of economic weakness in the eurozone, but don't expect too much more. If Draghi were to reverse course from last week and announce some extraordinary measure like another round of LTRO, it would not only erode the ECB's credibility, but could paradoxically have a negative effect on the markets as it asks, "What looming disaster does the ECB know about that we aren't aware of?"

QE3 in June?
Across the Atlantic, there is a lot of expectation built up that we are due for another round of QE at the June FOMC meeting in the wake of last week's ugly NFP report. Veteran Fed watcher Tim Duy disagrees  [emphasis added]:
Bottom Line: At this point, the direction of US data, the pathetic state of Europe, and the evolving slowdown across the rest of the world all point toward additional action by the Federal Reserve. Assuming this continues, it is an issue of timing and tools. My baseline is steady policy at the June meeting (depending, of course, on the usual financial turmoil disclaimer), with a possibility of an extension of Operation Twist. The latter option is something of a tough sell for me; it is cheap, but will prove to be ineffective. If the Fed needs to move, they need to reverse course back into quantitative easing. They need time to build internal support for such a move, which argues for action later in the summer or early fall, much as we have seen in the past two years. I just don't think they have enough to shift policy at this juncture.
Don't forget that Bernanke and the Bernanke Fed is made up largely of conservative academics, who tend to wait for definitive evidence of a slowdown before acting. As I wrote before about the difference between the Bernanke and Greenspan Fed (see Yes to QE3, but not yet), both the Greenspan Put and Bernanke Put exist, the difference is in reaction time:
[P]ut yourself in Bernanke's head. His academic reputation was built on the study of central bank action during the Great Depression. This is probably a little voice in his head telling over and over again, "Don't let another Great Depression happen on your watch." As a result, we have the Bernanke Put.
Greenspan had a long career on the Street as a forecasting economist and tended to be more proactive:
Greenspan's approach as Fed Chairman was to stimulate whenever he saw signs of weakness - and he was far more market savvy than Bernanke. Therefore the Greenspan Fed tended to be more proactive and tended to get ahead of events. The Great Moderation was the result of the Greenspan Put - and those policies worked well, until they went overboard with the stimulus (and we are still paying the price for those policies).

My guess is that investors looking for hints of another round of QE from the Fed on Thursday are likely to be disappointed.

Cam Hui is a portfolio manager at Qwest Investment Fund Management Ltd. ("Qwest"). This article is prepared by Mr. Hui as an outside business activity. As such, Qwest does not review or approve materials presented herein. The opinions and any recommendations expressed in this blog are those of the author and do not reflect the opinions or recommendations of Qwest.

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1 comment:

Unknown said...

I agree with the conclusion and think the upcoming political elections will also play a role in keeping the central banks on hold. I detailed my thoughts here:
The reaction will be interesting if Fed discussion focuses on extending Operation Twist, which apparently isn't considered QE but maybe in the future.