Kristina Hooper, CFP®, CIMA® is head of portfolio strategies for Allianz Global Investors Distributors LLC. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
No news out of Jackson Hole, Wyoming last week may be a good sign that central bankers have a viable game plan for jumpstarting the job market and the economy.
At first blush, Federal Reserve Chairman Ben Bernanke’s speech on Friday at the Federal Reserve Bank of Kansas City Economic Symposium seemed to be more of a history lesson than anything else. It was largely a backward-looking assessment of monetary policy, particularly the unconventional methods used to combat the financial crisis that erupted in 2007. There was no discussion of new policy tools or strategies.
Initially, stocks dropped significantly in the absence of any new insight on how or when the Fed will step in to invigorate a sluggish economy. But as traders and investors digested his remarks, stocks reversed course and finished in positive territory.
While the knee-jerk response to a lack of new information was understandable, a closer look at his keynote address reveals there are three good reasons to take encouragement:
First, he offered support for the argument that the type of unconventional monetary policy the Fed has employed in the past few years—and appears poised to use again—actually works. He cited a study based on the Board's FRB/U.S. model of the economy which found that, as of 2012, QE1 and QE2 “may have raised the level of output by almost 3% and increased private-payroll employment by more than 2 million jobs, relative to what otherwise would have occurred.” He also mentioned that researchers have found “the financial and macroeconomic effects of the British programs to be qualitatively similar” to that of the United States.
His message was clear: The Fed is not out of “ammunition” and it is his view that large-scale asset purchases are an effective instrument of monetary policy. However, these programs are not without potential negative effects, such as impairing securities markets by becoming too dominant a player or reducing public confidence in the Fed’s ability to execute a smooth exit strategy at the appropriate time.
Second, Bernanke conveyed a sense of urgency by reminding us that the Fed has dual goals seemed to suggest an order of priority for those goals: promoting “a return to maximum employment in the context of price stability.” Bernanke devoted a good amount of time in his comments to the debilitating effects of high unemployment. While he recognized that unemployment has fallen since its peak during the financial crisis, it remains more than 2 percentage points higher than what most Federal Open Market Committee members believe is an appropriate long-run rate of unemployment. Bernanke is clearly disappointed with recent progress, and highlighted that there has been no net improvement in jobs since January. He stressed that unemployment is “of grave concern” and that unless we see higher economic growth, it is unlikely to normalize any time soon.
Third, Bernanke discussed the Fed’s ability to lower unemployment. He dismissed the view that the unemployment rate hasn’t improved because of longer-term structural problems stemming from the financial crisis. He believes elevated unemployment is cyclical, not structural, the result of a host of factors that are creating “headwinds” for the economy, including housing, fiscal tightening on a state and federal level (including uncertainty created by the impending fiscal cliff), tight credit policies for some borrowers and financial stresses caused by the euro-zone crisis. For example, the implications of public sector fiscal tightening can be seen in this year’s gross domestic product numbers, which show a preliminary 0.2% drop in federal, state and local government spending in the second quarter following a 0.6% decline in the first quarter. While these problems are daunting, Bernanke expressed confidence that they can be addressed through monetary policy. He finished with a familiar pledge: The Federal Reserve stands ready to take the necessary actions “to promote a stronger economic recovery and sustained improvement in labor-market conditions in a context of price stability.”
Given the Fed’s confidence in its ability to rejuvenate the economy and its seeming willingness to do so, perhaps it’s no surprise that stocks recovered on Friday afternoon and finished August in positive territory. Further underpinning the cause for optimism is a stealth rally in the past four weeks, with small-cap stocks and gold up significantly, indicating investor expectations that the Fed will act—and soon. Both small caps and gold have typically performed well in periods of negative real interest rates and this time appears to be no exception.
Looking ahead, the next few weeks are likely to continue to center around employment and central banks, with the European Central Bank meeting on Sept. 6, the latest employment numbers due out on Sept. 7 and the next FOMC meeting slated for Sept. 12-13.
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