Bernanke fails to rule out QE3

IN A testimony to the US Congress yesterday, Federal Reserve chairman, Ben Bernanke largely rehashed language used in recent speeches, such as his address at the Jackson Hole symposium in August and his speech to the Economic Club of Minnesota on 8 September. However, forex market reactions leaned more on what the Fed chairman didn’t say than what he did.

In remarks to the Congressional Joint Economic Committee, Ben Bernanke left the door wide open for a third round of quantitative easing (QE3), in a climate where the Fed chairman has received strong criticism for his trigger-happy approach to monetary intervention. Attacking the Fed chairman has become a rite of passage for Republican presidential nomination hopefuls, and last month senior GOP lawmakers sent an open letter to the Federal Open Market Committee (FOMC), urging them not to act on plans for further stimulus measures. Yesterday Bernanke acknowledged that “monetary policy can be a powerful tool, but it is not a panacea for the problems currently facing the US economy.”

Bernanke devoted some of his time to justifying Operation Twist, launched on 21 September, despite opposition from 3 of the 10 officials on the FOMC. Financing the purchase of longer-term bonds with the sale of $400bn worth of short dated securities, the Fed tried to flatten the US yield-curve and suppress interest rates. The Fed also announced it will be reinvesting proceeds from maturing mortgage-backed securities back into the same instruments to try to stimulate the housing market.

However, despite these actions, the man at the central bank in Washington DC cannot make the man in Indiana spend, the business in Michigan borrow or the factory in Maryland hire (see chart, below left).

Bernanke was strong in his calls for government intervention in the “labour markets, housing, trade, taxation and regulation.” However, as Richard Farlet, partner in the leveraged finance practice of Paul Hastings points out, this may be a sign that Bernanke feels he is being backed into a corner: “I think his message is that he is running out of bullets and the political branches of government need to get their act together or the economic consequences could be Draconian.”

The lack of any new quick-fix monetary Viagra being prescribed by Dr Bernanke took the edge off the dollar’s recent rise. But with the Fed chief coyly hinting that a stimulus at a later date was not out of the question, it is unlikely that this will be a long-term issue. “There was a brief respite in the dollar surge as the market was reminded that the Fed chairman is unabashedly in favour of doing more easing if the Fed feels it is warranted,” says John Hardy, consulting FX strategist at Saxo Bank. But with market focus being largely on the European sovereign debt shambles, Bernanke may choose to keep his head below the parapet for a while, safe from sniping by US legislators. “The bar for QE3 is much higher than it was for QE2,” says Hardy. “Especially now that we have to sit back for at least a few months and watch Operation Twist fail to revive the economy.”
In a day that saw major US banking stocks take a battering – notably Warren Buffet’s bathtub baby, the Bank of America – the markets took some reassurance that Bernanke had not ruled out the use of further tax-dollars to inflate the equity market. “Bernanke’s remarks yesterday afternoon at the JEC in Washington acted as a cushion or support mechanism for global risk appetite and asset prices, and therefore a modestly weaker dollar,” says Stephen Gallo, head of market analysis at Schneider Foreign Exchange.

Whatever Bernanke may have said in yesterday’s testimony, he knows, and the markets know, that the Eurozone turmoil has the greatest potential to rock global forex markets. The Fed chairman could have addressed Congress in a monkey suit and haven flows out of Europe and into the dollar would have continued unabated. Traders used the potential of additional stimulus moves to take short-term dollar profits, and in doing so eased over-bought conditions. But according to Colin Cieszynski, market analyst for CMC Markets Canada: “It does nothing to change the greenback’s role as a haven for capital in troubled times. It’s still decisions in Europe regarding the Greek debt problem and how to shore up the European banking system that matter and should play a larger role in driving the dollar in the coming days and weeks.”