Fed Chief Paves the Way for More Easing—Just in Case

Fed Chairman Ben Bernanke paved the way for more quantitative easing on Friday, but he didn't speak with the urgency that some in the markets wanted to hear.

Ben S. Bernanke, chairman of the U.S. Federal Reserve, center, arrives for an opening dinner and reception at an economic symposium sponsored by the Kansas City Federal Reserve Bank at the Jackson Lake Lodge in Moran, Wyoming, U.S., on Thursday, Aug. 30, 2012.
Travis J. Garner | Bloomberg | Getty Images
Ben S. Bernanke, chairman of the U.S. Federal Reserve, center, arrives for an opening dinner and reception at an economic symposium sponsored by the Kansas City Federal Reserve Bank at the Jackson Lake Lodge in Moran, Wyoming, U.S., on Thursday, Aug. 30, 2012.

Now investors are focusing on next week’s economic data, particularly the August jobs report Friday, to see if it will show enough weakness to motivate the Fed (learn more) to act.

Bernanke’s long-awaited speech in Jackson Holewas a repeat of his past statements. He basically laid out why he believes past Fed easing has worked and the risks of further easing, but he consoled markets by suggesting the Fed could do more.

“The cost of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant,” he said.

Stocks initially sold offwhen traders saw no hard promise of easing in the Bernanke speech, but then rebounded to give the Dow a triple digit gain. Treasury yields fellafter Bernanke’s speech, with the 10-year yield dipping below 1.60 percent as buyers moved in.

“Bernanke has laid the groundwork for taking future action should it be needed—whether any additional action will make a difference is an open-ended question,” said Michael Sheldon, chief market strategist at RDM Financial Group. “However, the fact the Fed remains open has probably provided a floor for markets.”

The Fed chairman also said headwinds to the economy could make the case for the Fed to extend the time frame for its extremely low rate policy. Many Fed watchers have been expecting the Fed to change the expected end date to 2015 from 2014 when it meets Sept. 12 and 13, and Bernanke’s comment was taken as confirmation of that.

J.P. Morgan economists reiterated after the speech that they expect to see the FOMC act in September.

“After today’s speech we remain of the view that the odds are still strongly tilted in favor of an extension of the rate guidance at the next meeting," they wrote. "And while it is a closer call, we do believe this will be supplemented with more asset purchases, including MBS, perhaps executed in a smaller, more incremental, manner.”

San Francisco Fed President John Williams earlier Friday told CNBC’s Steve Liesman that rates could stay low for three more years.

“I don’t know that [Bernanke's] doing anything additional,” said Dan Greenhaus, global market strategist with BTIG. “The speech reads to me like a reinforcement of the Fed minutes—that voting member seem to be leaning towards or are in favor of additional easing.”

The minutes from the last Fed meeting Aug 1. showed that many FOMC voting members were in favor of further easing, but improving economic data and comments from some Fed officials since then dampened expectations that the Fed would act in September.

Greenhaus said he sees a 50-percent chance of Fed action at the next meeting, though some economists see a much lower probability. (Watch: What Happens After Jackson Hole?)

“It was pretty strident,” said David Ader, chief Treasury strategist at CRT Capital of Bernanke’s speech. “Again he brings up fiscal cliff issues, European issues that are outside of the Fed’s control. Nothing new, but he really when out of his way to say what we’ve done is right and it will still have impact.”

Ben Bernanke in Jackson Hole on August 31, 2012.
Ben Bernanke in Jackson Hole on August 31, 2012.

Markets have been expecting the Fed to carry out QE3 (learn more), a third program of asset purchases. Fed watchers believe in the next round, the Fed would buy a blend of Treasury bonds and mortgages. It currently is conducting Operation Twist, a program under which it buys long term Treasury securities and sells shorter duration securities, which does not expand its balance sheet like it does in QE.

Ader said Bernanke’s comments on the unemployment situation were particularly strong. Employment is one of the Fed’s dual mandates (the other being inflation). Bernanke blamed high unemployment on the financial crisis and said the economy is constrained by fiscal policy.

“The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years,” Bernanke said.

On Thursday, Atlanta Fed President Dennis Lockhart told CNBC’s Steve Liesman that the Fed could take action if monthly job creation fell below 100,000, but for now more easing is a “close call.” The July jobs report showed the creation of 163,000 non farm payrolls, and the expectations for August are about 120,000 new jobs.

Ader said Lockhart has now signaled what level could be a trigger, and markets will be watching the employment report closely for a break below 100,000. “The real questions is, we know the triggers, but the timing. Is it September? Is it November? or is it later on?” he said.

Later in the year, or early next year would make sense since the Fed would then know what was happening with the fiscal cliff. the so-called fiscal cliff is the dual expiration of Bush tax cuts Dec. 31and the start of automatic spending cuts that would take place if Congress does not act before then. The Fed has warned that Congress must take action on fiscal matters.

“If you look at the FOMC minutes, 10 times they talked about the fiscal constraints here and in Europe, the pending austerity,” Ader said. “My bias is he’s going to keep it out there. The forward guidance will come first, and they’ll wait for the new year to see if something happens on the fiscal cliff side. If we have two or three months of sub 100,000 job growth, that seems to be a trigger.”

RDM Financial strategist Sheldon said if the Fed or European Central Bank takes away the promise of more easy policy, the market would react negatively.

“Given the nature of the recent economic data," he said, "it’s unlikely that the Fed will release additional QE. We need weak data for the Fed to take action.”

Follow Patti Domm on Twitter: @pattidomm

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