Analysts as Split on More Monetary Easing as Fed Is

The market had been focused on Federal Reserve Chairman Ben Bernanke’s speech at Jackson Hole on Friday all week, and when it was finally delivered, his message on further quantitative easing left a lot of investors feeling underwhelmed.

Federal Reserve Chairman Ben Bernanke
J. Scott Applewhite
Federal Reserve Chairman Ben Bernanke

Stocks initially fell on the news but then rallied as investors digested word that the Federal Open Market Committee will hold a two-day meeting on September 20 where members plan to discuss the central bank's response to the dramatic slowdown in economic data over recent weeks.

In July the Fed Chairman told investors which measures are at the FOMC’s disposal should it decide on a third round of unconventional policy measures—QE3 in market parlance. These include buying more securities, cutting the interest on excess reserves, selling short-term debt and buying longer-dated bonds, or giving guidance on the when the Fed will begin to shrink its balance sheet.

At the August meeting, the Fed pledged to keep rates at historic lows for the next two years, so there is already considerable assistance for the economy on the table. But the next 3 weeks will see analysts and economists debating what the central bank should do next.

“We expect the Fed to announce new measures as the economy is struggling and we expect to see weak data over the coming month” said Danske Bank Chief Economist Allan von Mehren following the Bernanke’s speech at Jackson Hole. “The question is what kind of stimulus we will see. It is not clear if it will be QE3, as there appears to be some opposition to this within” the FOMC.

This division within the FOMC is why, in von Mehren’s opinion, Bernanke chose simply to not reiterate the possible choices at the Fed’s disposal this time around.

On Thursday the President of the Kansas City Fed, Thomas Hoenig told CNBC that he did not favor QE2 so therefore could not back QE3.

On Friday Charles Posser, the President of the Philadelphia Federal Reserve told CNBC that policy has been “extremely accommodative” telling CNBC’s Steve Liesman that the Fed was “too pessimistic” about the prospects for the US economy. Watch the Plosser interview here.

It may be that we learn more about the Fed’s intentions from the minutes of the August meeting, which are due to be released on Tuesday according to Paul Dales, the chief U.S. economist at Capital Economics.

“Bernanke did not even elaborate on what tools the Fed could use. This is a marked difference to the detailed discussion of the various options in last year’s Jackson Hole speech, which paved the way for QE2,” said Dales in a research note.

With core inflation still high, Dales predicts QE3 is unlikely until next year and then will fail to give the economy or risky assets as much assistance as QE1 and QE2 did. Bernanke will though attempt to apply pressure on the politicians, in Dales' opinion.

“Bernanke devoted a large part of his speech to urging Washington to put the fiscal position on a 'sustainable path' without disregarding the 'fragility of the current recovery.' In short, he appeared to be saying that the politicians need to start pulling their weight," he said.

It could also be the case that Bernanke is hoping for a turn around in the economy over the next few months and is therefore reluctant to take further action until he can see more evidence on the economy.

“The Federal Reserve—just like us—expects growth to accelerate again somewhat in the second half of the year. If that scenario materializes, the FOMC is unlikely to embark on another round of asset-purchases any time soon,” said Harm Bandholz, chief US economist at Unicredit Research.

“Any potential further easing will then focus on the composition of the balance sheet, e.g. extending the maturity structure of the Fed’s asset holdings,” said Bandholz, who believes QE3 is not off the table given all the risks to downside facing the US and global economy.