Don't Hold Breath For New Fed Action in Jackson Hole

Those looking for a clear and unambiguous green light for QE3 from Fed Chairman Ben Bernake’s much anticipated speech in Jackson Hole on Friday could be disappointed.

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There are three reasons that add up to Bernanke likely falling short of market expectations for an all-out endorsement of additional Fed action at the annual meeting of central bankers in Wyoming the way he telegraphed QE2last year.

First, the Fed just took substantial action at its meeting earlier this month, all but promising to keep interest rates low for as long as two years. The unprecedented pledge, along with heightened concern over a recession , has helped push down treasury yields .

Second, just because it happened last year, markets should not to expect it to happen again. It is somewhat rare for the Fed Chairman’s Jackson Hole speech to be used to signal major policy changes—more likely he'd use it to signal a change in the outlook. But again, since the Fed fairly severely downgraded the outlook in its recent policy statement, Bernanke should be expected to hew pretty closely to that outlook.

It’s also rare for a Fed chairman, especially one this consensus-oriented, to get too far out front of his committee. The August policy statement clearly showed a willingness of the committee to conduct additional asset purchases.

“The Committee will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate,’’ the statement said. “The Committee discussed the range of policy tools available to promote a stronger economic recovery in a context of price stability. It will continue to assess the economic outlook in light of incoming information and is prepared to employ these tools as appropriate.”

Despite such strong hints that they are serious about considering QE3, there is no sense that the committee has decided to use these tools, at least not on the eve of the Jackson Hole speech.

Third, the recent policy change at the Fed sparked stiff opposition. Three FOMCvoting members, all district bank presidents, voted against the policy, the first such explicit opposition in 20 years. At least two other Fed presidents are known to oppose QE3 at this time.

Time may not change this tally, but a clearer weakening in the outlook could bring around two presidents, possibly Narayana Kocherlakota of Minneapolis (a voter) and Jim Bullard of St. Louis, both of whom have supported more activist Fed policy in the past.

The speech is fraught with danger for Bernanke and markets. The August CNBC Fed Survey showed 46 percent of respondents expecting QE3 within the next 12 months, up from 19 percent in the July survey.

The percentage of respondents saying there will be no additional purchases fell to 37 percent from 68 percent, with 17 percent saying they were unsure. The average size of the next QE round rose to nearly $700 billion, just short of double the expectation in July.

So, the policy is increasingly being baked into market expectations. Moreso, any Fed chairman has to be careful not to offer a description of the economy that is so bleak without appropriate policies to combat that weakness. In other words, the Fed is expected by markets to describe the economy as either where it wants it to be or roughly on the way there through the appropriate policy. Not green-lighting QE3 could put the Chairman in the position of offering a dire economic description without a sufficient policy prescription.

So the most likely outcome from Jackson Hole is an economic outlook that mirrors the one offered by the committee in August, holding open the possibility of additional action, including lengthening the maturity of the Fed’s holding of maturities.

And just because it won’t happen in Jackson Hole doesn’t mean it won’t happen. A strong signal could be issued as soon as the lead up to the Sept. 20 meeting.

But at this point, with so much opposition and the Fed having taken such a strong step earlier this month, Bernanke is unlikely to give an unambiguous go ahead for QE3 in Jackson Hole, at least not one as strong as the market seems to be expecting.