The business of America is business, but once every four years the electoral cycle takes over as voters decide on who should be their President. Incumbents generally need a strong economy if they want to be re-elected and so the ground work needs to be done with a year to go. That means now.
Recent pronouncements both by President Obama and Chairman of the Federal Reserve Ben Bernanke were designed to set the political and economic agenda for 2012. I commented about the three main events;
- Ben Bernanke Steps Up To the Plate in Jackson Hole - 25th August 2011
- President Obama's Goldilocks Moment - 9th September 2011
- US News - Is that it until 2013 - 26th September 2011
Ben Bernanke Steps Up To The Plate in Jackson Hole
Despite the best efforts of all concerned confidence has continued to deteriorate. The relative performance of bonds and equities tell us what the market thinks. The dollar, which is probably the best indicator of stress in the global financial system, has been strong.
Those looking for a positive signal about global economic growth should look for a reversal of recent trends.
The great and good are currently gathering for the annual Economic Policy Symposium in Jackson Hole, Wyoming. Financial markets around the world will be listening very carefully to what the Fed Chairman Ben Bernanke has to say when he delivers his speech on Friday.
This time last year he first talked about QE2 and because markets are worrying about lack of economic growth, there is growing anticipation that ‘Helicopter Ben’ will yet again ride to the rescue.
August has been a difficult month. We have heard from the ECB that “all necessary measures to support financial stability and growth will be taken.” Less than 3 weeks ago the Fed issued a statement promising unchanged interest rates for two more years. Markets have been underwhelmed. Are there any more tools in the box?
To answer this question we must go back to 2002 when Ben Bernanke delivered a speech to the National Economists Club in Washington in which we set out what actions could be taken if there was ever a risk of deflation in the US. What he did not realise at the time was that in this speech he defined the agenda for his time as Fed Chairman.
In summary he said;
- Preventing deflation is easier than curing it.
- Make sure that the banking system and capital markets are well capitalised and liquid.
- Central banks should act pre-emptively and aggressively in cutting interest rates.
- Print money.
- Lower long term interest rates.
- Commit to holding overnight interest rates at zero for a specified time.
- Attempt to influence the yields on privately issued securities.
- Work with the Treasury to weaken the Dollar.
- Cut taxes across the board – this is where the helicopter drop of money comment came in, although he was quoting Milton Friedman.
Fast forward to August 2011. QE1 and QE2, together with the interest rate commitment have moved us along to points 5 and 6, and taking into account that the Fed has a further $600 billion to spend on asset purchases over the next 2 years it could be argued that we are already have QE2 ½. Tax cuts are off the political agenda until 2013. So what next?
In reality the US economy is still just about growing and there is inflation not deflation. Despite political pressure to deliver growth in time for next year’s election and, taking into account that it is only a few weeks since the interest rate commitment, Mr. Bernanke may decide that his priority this weekend is ‘first do no harm’. Until there is a clear need for QE3, anything too aggressive could destabilise markets.
Obviously there will be disappointment if there is no news, but markets should probably be satisfied with a plan to lower long term Treasury yields and some fine words. If, however, he does reach the toolbox he better make sure that he finds the sonic screwdriver.
President Obama’s Goldilocks Moment
This is the second in a series of three notes about US economic policy. On Thursday President Obama will address a Joint Session of Congress about economic policy. Although he will be in competition with the opening game of the National Football League season, make no mistake, this is an important and unusual event.
In Jackson Hole Ben Bernanke stuck to the agenda that he originally set out in 2002. No new money was spent or created and he gave markets something to look forward to with an extended two day Fed meeting on 20th and 21st September. These meetings are normally only for one day and so why meet for two days if there is nothing to announce? The market view was that it is better to travel than arrive and at least it made a change from the almost daily grind of disappointing economic statistics. There was, however, a very slick buck pass. He made it clear that monetary policy on its own (under the control of the Federal Reserve) would not be enough to sustain growth. The clear message was “over to you Mr President” to marshal the resources of the US government.
Joint Sessions of Congress are relatively unusual. The stakes are high both politically and economically. Politically this could be Obama’s last chance to set the economics agenda for the 2012 election campaign. On the fiscal front his options are limited by the profound differences of opinion between Republicans and Democrats about both taxation and spending. The focus will, therefore, be on employment, but it is also possible that housing could be on the agenda. Both issues have the potential to win votes.
Left to its own devices the US economy is strong enough to be self-righting. Debts will be paid off or defaulted on, companies that over indulged in the credit bubble will be restructured and people will relocate or learn new skills in order to find jobs. All of this will take time and so the temptation will be to be more radical in order to jump start the recovery in time for next year’s election. This is the Presidents dilemma.
If his plans are judged to be insignificant or just more words then markets will return to the reality of a slowing economy and come under renewed pressure. If he is too radical then he runs the risk of scaring investors. In this event the dollar is likely to weaken.
Although investors will need to listen very carefully because the risk of policy error is high, I suspect that his words will be more radical than the actual solutions put forward and that he will do just enough to be able to pass the buck back to Bernanke for the Fed meeting in a couple of weeks time. A Goldilocks speech is needed, not too hot and not too cold.
US News - Is that it until 2013
The Federal Open Market Committee (FOMC) duly met for two days last week, completing the cycle of three set piece events in the US over the last month designed to set the political and economic agenda for the next year. Despite many fine words and some interesting plans the market reaction was clear cut. Risk – off is back in fashion with US Treasuries up and equities down in the following days. The question for those looking for a reason to be optimistic was – is that all?
Ben Bernanke’s Jackson Hole speech is part of the annual calendar, but could have been the catalyst for a recovery because of what happened in 2010. In the event he outlined the Fed’s options, following the action plan he set out in 2002, and then passed the buck to the President.
President Obama’s speech to a joint session of Congress was an unusual event. He asked for it and, after being kept waiting for an extra day, was invited on to the platform. He was expected to deliver something special. His speech contained several major initiatives which, if implemented in full, could add between 1.5% and 2% to US economic growth next year.
Unfortunately for the President it is unlikely that the Republican controlled House of Representatives will pay much attention. Instead the lasting impression is that the speech had more to do with electioneering than putting America back to work.
So markets were left with two weeks to anticipate the FOMC meeting on 20th and 21st September. Again this seemed to promise something special because the usual one day gathering had been extended to two. The announcement when it came offered slightly more than had been anticipated with Operation Twist at the high end of expectations and with mortgage backed bonds included for the first time. The plan is to sell $400 billion of shorter dated bonds maturing over the next three years and reinvest in longer dated securities due to be redeemed between 6 and 30 years from now. The Fed hopes that this will lower long term interest rates and so stimulate loan demand and economic growth. No new money is to be created, which will please the Republicans, and the consensus is that this rather technical operation will have relatively little effect on economic growth or confidence. In fact any potential benefit was cancelled out by the accompanying statement which downgraded the economic outlook from ‘downside risks’ to ‘significant downside risk’.
Unlike voters who will have to wait another twelve months to exercise their democratic right, investors who get to vote all day every day decided that 2012 was likely to be a tough year for growth and voted accordingly.
The issue now is why so much effort has delivered so little. There are various possibilities. It could be that the Fed has run out of options and in the absence of political leadership nothing more can be done until the voters have their say. That means waiting until 2013 when the President (existing or new) will have a mandate for action. Alternatively, and I think more likely, the Fed spent the extra day on scenario planning in anticipation of European trouble.
Europe might be outside the Fed’s mandate but there would be collateral damage amongst US banks if there are unplanned defaults by European governments (Bernanke 2002 action plan; make sure that the banking system and capital markets are well capitalised and liquid) and recession in Europe could hardly be considered good news for the US economy as a whole.
If European governments fail to solve their debt problems then the US will need a plan. Just as Pearl Harbor allowed Roosevelt to redefine American international policy, problems in Europe could provide cover for the Fed and US Treasury to implement more radical action to stimulate growth sooner rather than later.
