Monday, August 27, 2012

All eyes on Jackson Hole

The key focus for markets this week will be Ben Bernanke's speech at the central bank conference in Jackson Hole, Wyoming.  This is the conference at which he effectively announced QE2 was coming in 2010.

Speculation on a third round of quantitative easing (or QE3) went up a notch last week with the release of the August Federal Open Market Committee (FOMC) minutes.  The Fed is clearly ready to pull the trigger on more easing, should it be needed.  It's the last part of that sentence that still has me still happy with the view that more quantitative easing is less than a done deal.

The minutes reflect a point in time when the committee had just witnessed a number of sub-par economic data including soft employment and retail sales growth.  Since then the data has improved, but only to the extent that it confirms the US economy is growing at around a 2% annual pace which is only sufficient for a gradual trend decline in unemployment.

Furthermore, if the Committee is concerned about business confidence, we think recent developments in Europe (assuming the ECB eventually does something) will ultimately have a bigger impact on global confidence than another round of QE will have on confidence levels in America.

There is still news to come that will be critical to the Committee’s decision in September.  This week we will see the second estimate of Q2 GDP.  Market expectations are for an upward revision from 1.5% (saar) to 1.7%.  Most critical of all will be labour market data due September 7th.

And of course before that we get Bernanke's speech from Jackson Hole.  The interesting bit in that speech will be any hints of what form further easing might take.  The fact that another round of quantitative easing will have limited impact on real economic activity is well understood.  Even Bernanke believes that successive rounds of quantitative easing face diminishing returns.  At the same time, some of the FOMC members have voiced interest in the UK’s recent “Funding for Lending” program.  Such a program might improve the cost/benefit balance by reducing the potential costs of negatively impacting Treasury market functioning (a key concern for some FOMC members) while improving the potential benefits by implementing a more targeted program.

The important point from the minutes is the Fed is clearly prepared to act.  They haven't come this far to throw in the towel now.  But that still leaves the odds of further easing in September at 50:50.