I've done a careful read-through of Bernanke's Jackson Hole speech and made some comparisons to notes I made from his 2010 and 2011 speeches. Given the progression of the financial crisis since then, the speech is focused around which "nontraditional policies" have been effective, and how. I would note that this speech bears a lot of similarities to his 2010 speech, in the way it is laid out from top to bottom.
Bernanke states that the goal of the Fed's purchases is to force investors to rebalance their portfolios with "other assets." Later in the speech, he mentions that asset purchases help push investors into more risky assets; in previous speeches, he has mentioned "longer-duration, risky assets."
This was by far the most interesting part of the speech to me: He mentions James Tobin's suggestion that after the Great Depression the Fed should have purchased longer-term securities since short-term rates were already near zero. He also notes that Milton Friedman argued for large-scale purchases of long-term bonds by the Bank of Japan to help overcome deflation in Japan. Anyone see a theme here? I did a word search of his previous Jackson Hole speeches and there was no mention of either of these economists.
The most ironic thing to me was that Bernanke said there is some evidence that periods of QE (which he calls LSAPs, meaning large-scale asset purchases) has boosted stock prices.
Bernanke also notes that by Fed calculations, QE has boosted output by 3% and has created two million private sector jobs. This is the first of many mentions of the output gap in the speech.
In the rate guidance section, he discusses new communication methods for the FOMC's language of keeping the "rate low through an extended period of time." He discusses the fact that the rate is determined by "familiar determinants, such as inflation and the output gap." There was not as much here as I had expected, in terms of tackling the question of communication.
He is worried that additional purchases may impair the functionality of the securities markets. He also notes that the Fed may become too big in the Treasury and MBS market, and thus impair liquidity. Additionally, he worries that with additional purchases the Fed may lose "public confidence" that it can exit the market at a further date. Can't blame him here -- if the Fed starts to sell, it might start a 1-800-GET-ME-OUT effect, as the Fed is a giant amongst giants in these markets compared to other central banks and governments. He also worries that the Fed's balance sheet may get too big and inflict financial losses on itself if "interest rates move in an unexpected manner." With a weighted average of 9.31 years, the Fed's DV01 (dollar loss per 1bp move in interest rates) is about $1.52 billion in Treasuries alone.
The magic sentence: "The costs of nontraditional policies (QE) appear manageable," and he does not "rule out the further use of such policies if economic conditions warrant."
Some of the reasons he lists for the lack of a robust recovery include a weaker housing market, less of a housing recovery than he would have liked, and that housing activity remaining at lower levels than would be desired to contribute to the recovery. He also states that limited credit availability is holding back growth.
He does state that monetary policy is not as effective as broader fiscal policy and cannot achieve the same results as broader, more balanced fiscal policies. This is a punt to the politicians -- or it blames them, depending on how you see it.
He references his 2002 speech, which I find most interesting. During this speech, he has effectively laid out his game plan for how he would attempt to tackle future financial crises. If you haven't read it, I highly suggest it.
In conclusion, I think that while this speech had some similarities to his 2010 speech, it is much more cautious. It definitely makes the case that the Fed is not in a position to conduct additional large-scale asset purchases (or LSAPs) unless conditions deteriorate significantly. I'm hearing very similar conclusions from the other people in the market that I talk to.
It also makes the case that the Fed would probably buy mortgage debt vs. Treasury debt, if they do so at all.
I also think, given some of his comments, that we may see new communication on certain targeting in nominal GDP (the output gap), inflation, and unemployment. But that is just speculation, and it could be confirmation bias.
I also thought it was odd that he mentions "limited credit availability" as something that is holding back growth. This is at odds with what I have been told by those in the banking and financial industry. In the majority of cases, the problem is that most people do not want to take the risk of starting loans. There's also the case where those who want loans can't get them, and those that can, don't want them. Admittedly, I might be reaching a bit there, but this might be the difference in the academic view and the real-world view.
Now we wait for Draghi and the ECB next Wednesday, which is arguably the much more important event.
No positions in stocks mentioned.
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