Friday, August 27, 2010

Bernanke At Jackson Hole

Here's some thoughts on Mr. Bernnake's much-anticipated speech at Jackson Hole this morning (

1) His outlook for economic activity remains cautiously optimistic. This view is based on a combination of factors: ongoing repair of household balance sheets (as reflected in the higher savings rate), the corporate sector sitting on a lot of cash that can be gradually deployed for capital spending projects, and the continuing underpinning to growth from an exceedingly accommodative monetary policy moving forward). None of this sounds like an unreasonable premise. On the whole, we agree with his assessment that "preconditions for a pick up in growth in 2011 appear to remain in place". The term "double-dip" was conspicuously not mentioned at all, not even as a hypothetical risk that he does not envision.

2) He cast the Fed's recent decision to reinvest the proceeds of maturing MBS securities in its portfolio in coupon Treasuries as a defensive move designed to "avoid an undesirable passive tightening of policy that might have otherwise occurred". This is actually a fully accurate description of the recent Fed action, as it is essentially targeting the maintenance of the status quo in monetary policy and not the implementation of further accommodation.

3) Directly related to the above point is the realization- which seems to have flown mostly under the market's radar screen so far- that the weaker the pace of economic activity turns out to be over the coming months, the more aggressive the Fed's purchases of Treasuries are going to be, without any other change in Fed policy. This is so, because the further downward drift in rates that will result from any further weakening of economic activity will trigger a higher pace of mortgage refinancing activity and an accelerating rate of redemption in the Fed's MBS portion of its portfolio. Therefore, any further slowing in economic activity ahead will set into motion two powerful engines pushing long-term Treasury yields yields lower and causing a further flattening of the curve: the perception of a softening economy with the associated rising deflation risk plus the pick-up in the pace of Treasury purchases by the Fed.

4) Inasmuch as he discussed, in a fairly balanced fashion, the various pros and cons of some of the additional accommodative policy measures the Fed can consider in the future, he left no doubt that, if the pace of economic activity continues to degrade and the deflation risk is rising, the Fed will take additional action. At this point, he stated that there is no decision by the FOMC to activate any of the other possible such measures (increase the net size of the Fed portfolio, reducing the interest paid on bank excess reserves, or provide a specific time frame committing to a near zero rate policy in the FOMC statements).

Anthony Karydakis

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