Following the earlier note on the "irrational exuberance of QE3" at current conditions, Goldman does a one-two to the face of the long-only slow money crowd which are about to realize that what goes up the escalator, will go down the elevator, repeating that the next round of monetary easing "would require a notable further deterioration in the outlook to be considered seriously." As a reminder the only "outlook" the Fed keeps an eye out on is the 50 DMA of the Russell 2000.
Just out from Jan Hatzius:
Fed Chairman Bernanke's speech at the International Monetary Conference acknowledges slower growth but views this as at least partly due to temporary factors. Easy monetary policies “are still needed” given the economy continues to perform “well below its potential.”
1. Fed Chairman Bernanke began his remarks by acknowledging the "slower than expected" growth so far this year. He specifically cited supply chain disruptions stemming from the Japanese earthquake and tsunami as a factor slowing growth in Q2. However, despite the "frustratingly slow" pace of recovery thus far, Bernanke sees growth as "likely to pick up somewhat in the second half of the year" as manufacturing activity normalizes and gasoline prices ease a little.
2. Noting the headwind from fiscal drag, Bernanke emphasizes the need to “move quickly to enact a credible, long-term fiscal consolidation plan.” His wording makes clear that he sees a strong case for rapid decisions and action, but a tightening that is gradually phased in so as not to be “self-defeating”. Such a plan could also provide short-term benefits if it improved confidence and/or lowered long-term borrowing rates. In the question and answer session following the speech, Bernanke ducked a question asking him to choose between near-term stimulus and long-term tightening, repeating that he saw the problem as fundamentally long-term in nature.
3. Bernanke notes "the recent increase in inflation is a concern" but suggests that "there is not much evidence that inflation is becoming broad-based or ingrained in our economy". Given that gasoline prices account for most of the pickup in inflation, Bernanke takes the view that "developments in the global market for crude oil...rather than factors specific to the US economy" are the main driver of higher inflation in recent months. Bernanke goes on to argue that the sharp increase in commodity prices in recent years is primarily driven by strong gains in global demand alongside constrained supply, rather than the byproduct of easy Fed policies. In any case, he expects considerable labor market slack and stable long-term inflation expectations to keep US inflation restrained going forward.
4. No surprises in the commentary on monetary policy: "QE2" is to wind down at the end of the month, but reinvestment of principal payments on the Fed's securities holdings will continue. In Bernanke's words: "Although it is moving in the right direction, the economy is still producing at levels well below its potential; consequently, accommodative monetary policies are still needed. Until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established." That implies a fairly high bar for any monetary tightening. At the same time, there is of course no mention of the possibility of another asset purchase program--this would require a notable further deterioration in the outlook to be considered seriously. In short, we remain well within the “zone of inaction” for the Fed.
5. In the question and answer session following the speech, Bernanke attributed recent weakness in the US dollar partly to the relaxation of risk aversion following the crisis, and partly to the “quite weak cyclical position” of the US economy relative to many trading partners (especially emerging markets). In his view, the best way for the Fed to support the dollar “in the medium term” is to keep inflation stable and help the US economy recover.