Markets Could Be Making a Losing Bet on More Fed Easing
Investors betting that Federal Reserve Chairman Ben Bernanke is about to come to the rescue with another round of monetary easing could be setting themselves up for a major disappointment.
Bernanke's much-awaited speechduring the central bank's gathering at Jackson Hole, Wyo., later this week is setting up as a potential lose-lose situation: The chairman may not provide the market's desired signal for a third round of quantitative easing —or QE3—and even if he does it may not help.
That's the sentiment of a number of economists and strategists, despite a Monday market rallythat appeared to be fueled by speculation that Bernanke will ride to the market's rescue at the same time and under similar circumstances in 2010.
"The market's sending a signal to Bernanke saying, 'We want QE3 and we want it this week, or we're going to hammer you and the market will get absolutely killed,' " said Keith Springer, president of Springer Financial Advisory in Sacramento, Calif. "The stock market is addicted to QE."
Then, as now, Bernanke faced pressure to act after the market slid 17 percent in the summer of 2010 amid fears of European sovereign debt contagion and a double-dip recession in the U.S. The market has dropped nearly the same amount since coming off its early May 2011 highs and as one economist after another cuts projections for growth this year, to levels near 1 percent.
In 2010, Bernanke used his Jackson Hole speech—normally a low-key affair that vaguely charts the central bank's direction well into the future—to indicate that additional asset purchases were on the way to stimulate growth.
In November, the Fed announced $600 billion in Treasurys purchases that sent stocks on a sharp upward trajectory for eight months and kept interest rates at a relatively low level.
But since the summer slump, the S&P 500, while up about 6.5 percent since the Jackson Hole speech, is actually about 4 percent lower than when the second round of easing officially began.
The slowdown will add more drama to the direction Bernanke signals at Jackson Hole.
"We believe Bernanke’s Jackson Hole speech will include a detailed discussion of the potential for more easing through large-scale asset purchases," Goldman Sachs economist Zach Pandl wrote in a note. "A variety of indicators suggest many investors already expect more QE."
Pandl pointed specifically to a CNBC survey indicating that asset purchases already may have been priced into the market, meaning that more would be required to juice the market further.
Instead, Pandl expects the discussion to focus more on what is referred to sometimes as Operation Twist—a 1960s-era term that refers to the central bank's effort to compress the yield curve.
Rather than expand the already-bloated Fed balance sheet, the move would sell short-term debt and buy-long term debt, as a way to drive down long-term rates further and spur investment.
"Based on our conversations with clients, we believe investors would be very surprised if the speech did not include a discussion of asset purchases," Pandl wrote. "We see two main reasons why Fed officials may prefer to change the composition of the balance sheet as a first step...If used aggressively, this could have a sizable impact."
Whether that will be enough to assuage the market's thirst for even more of the unprecedented intervention that has taken place since the financial crisis is an open question.
Wall Street, though, seemed to be sending a signal Monday.
"Market up today only because (it) expects that Ben will come by helicopter to Jackson Hole to dispense QE3," Nouriel Roubini, head of Roubini Global Economics, tweeted on his Twitter account early Monday. "If he doesn't, (expect to) see market sharply down."
But investors banking on the kind of impact the Jackson Hole speech had last year may be let down.
"It definitely could be setting up for disappointment," said Dave Lutz, managing director of trading at Stifel Nicolaus in Baltimore. "People might be covering some shorts going into it. But I don't see traditional managers taking big bets going into Friday, given that it's such a high volatility event."
The market, then, could use the Bernanke speech not as an event to smooth the peaks and valleys that have dominated tradingover the past seven weeks, but rather to exacerbate them.
"The big thing is if he does announce it we're going to have a thousand-point rally. We'll be making new highs before you can blink," Springer said. "I am hedged right now, but you've got to have your finger on the button."