Jan Hatzius Attempts To Preserve The Fed Chairman's Mystique
Here is Jan Hatzius' initial read on Bernanke speech. In a nutshell, Hatzius seems to believe that reading between the lines may mean Bernanke will not do QE2, and preserve some of the Fed's mystique, so that all those massive bond managers who get the Fed's data early appear to have a competitive advantage. Alas, they don't. And all those who believe the Fed at this point, now that fiscal stimulus is no longer an option and all out FX war has broken out, has any other option but to buy anything not nailed down, well, we would like to point them to the 9 upcoming POMO monetizations over the next 4 weeks. What is most troubling is that the market has now priced in not only that, excluding some intraday volatility especially on OpEx days, but the expansion of Fed proxy buying of AAPL to $25 billion a week. Hatzius better hope that his attempt to restore some credibility to the Phantom of the Fed is grounded in reality. Because in the off chance he is right, buying a boatload of far OTM broad market puts on November 2 may well end up being the most profitable trade of the year, if not decade.
BOTTOM LINE: Chairman Ben Bernanke adopts a cautious approach to his speech, reiterating that he sees a case for adopting more stimulus but that any decision depends on the costs and benefits of the nonconventional policies. The speech contained few details of what form additional easing could take, although Bernanke clarifies that he regards additional asset purchases and/or a tightening of the FOMC’s guidance language as the primary tools. Overall, the speech is consistent with our expectation of a QE announcement in November.
1. Chairman Bernanke re-emphasizes the FOMC’s dual mandate of attaining the longer-run sustainable rate of unemployment and mandate-consistent inflation. With regard to the former he argues that “the bulk of the increase in unemployment since the recession began is attributable to the sharp contraction in economic activity … rather than to structural factors.” Bernanke thus refutes the idea that labor market mismatch has pushed up the structural unemployment rate significantly. Given this large amount of slack, Bernanke notes concludes that “it is reasonable to forecast that underlying inflation…will be less than the mandate-consistent inflation rate for some time.” The tone of this speech is consistent with the "bite size" approach to asset purchases that we have come to expect in the wake of earlier speeches rather than a "big bang" approach.
2. Given this deviation from the FOMC’s mandate he argues that “there would appear--all else being equal--to be a case for further action.” However, Bernanke is careful to stress that “possible costs must be weighed against the potential benefits of nonconventional policies.” The chairman provides few specific details but clarifies that he sees asset purchases and forward guidance as the primary unconventional tools too boost the economy. His remarks contained no comments on price level or nominal GDP level targeting.