Monday, August 22, 2011

Don't expect the Fed to throw another party

Last year, Ben Bernanke made a speech at Jackson Hole announcing the start of the Fed's QE2 program, which kicked off a stock market rally. (The Fed throws great parties, don't they?) This year, there seems to be a certain level of market expectation that we may see another Jackson Hole surprise.

Don't count on it.

Bullard's QE3 denial
First and foremost, James Bullard of the St. Louis Fed (an FOMC non-voter), who was one of the advocates of QE2 last year, clarified the FOMC statement that interest rates would stay low for another two years is not a signal for QE3 to start. Bloomberg reported that Bullard stated:
"The most likely outcome for the U.S. economy is still that the economy continues to grow at a moderate pace through the second half of the year,” Bullard said late yesterday in a telephone interview. “If the economy is substantially weaker than expected, we could take more action, especially if it was coupled with a renewed deflation risk.”
Second, the higher than expected PPI and CPI reports last week are not exactly comforting signals for Fed governors who are concerned about inflationary expectations.

The worst of all worlds
At the same time, we have signs of a decelerating economy. This long term chart of the ratio of coincidental to lagging indicators shows that the US economy is definitely in the danger zone.

...though this indicator did tick up this month:

Then we have the awful Philly Fed print last week. David Rosenberg showed this chart of his composite of the Philly Fed and University Michigan Sentiment Index. Need I say more?

In effect, we have the worst of both worlds - the combination of a slowing economy and a Fed showing reluctance to be more accommodative than they are today. On top of that, we have European banking system and sovereigns lurching from crisis to crisis. (What's the over/under these days the for number of days before another European "problem" erupts? 2 days? 3 days?)

In the absence of effective policy response, the intermediate term path of least resistance for stocks is down.

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