As the annual Jackson Hole Symposium approaches, there have been talks in recent days that Fed Chairman Ben Bernanke will probably disappoint the market, i.e. he will not hint about additional easing. Look at yesterday's price movements: the advance in the USD, the sharp decline in US Treasury and the selloff in gold, it suggests that investors are reducing their speculations on QE3 in August. The title of Bernanke's speech this year is 'Near and Long-Term Prospects for the US Economy', compared with last year's 'The Economic Outlook and Monetary Policy'. Some market participants said the Chairman omitted 'monetary policy' as he wants to tune down hopes of further policy action.
We expect Bernanke's speech will focus on 1) US economic outlook; 2) review of policy actions and 3) discussion of policy tools. As indicated in the August policy statement, policymakers viewed that growth has been 'considerably slower' than expected. Temporary factors including 'higher food and energy prices' and 'supply chain disruptions' associated with the earthquake in Japan' accounted for 'only some of the recent weakness in economic activity', suggesting the slowdown has been driven by more pervasive factors. The recovery will take place at a 'slower pace' with increasing downside risks in the economic outlook over coming quarters and the unemployment rate will 'decline only gradually' toward levels consistent with the Committee's mandate.. While revising down the economic outlook, policymakers were not completely pessimistic. New York Fed President William Dudley said last week that US data were 'at worst, mixed'. Banks are 'in much better shape' with 'huge liquidity buffers compared to where they were in 2008'. He expected that there would be 'stronger growth in the second half'. Cleveland Fed President Pianalto, who has never dissented from an FOMC decision, said she forecast US' GDP will grow 'at a rate of about 2% this year, and about 3% in each of the next 2 years'. The Chairman will probably elaborate more about the central bank's view on the growth prospect.
As we showed in the article titled 'Evaluation of QE2 and Preview of Possible QE3 Ahead of Jackson Hole Symposium', the impacts of QE2 on bolstering economic growth were not significant. Inflationary pressures were, however, lifted after liquidity injection. The situation should have triggered questions about effectiveness of easing measures. We expect the Chairman to address the issue at the conference. At the same occasion last year, the Chairman stated central bankers 'alone cannot solve the world's economic problems'. He will probably reiterate similar stance this year.
The August FOMC statement unveiled that the Committee had discussed 'the range of policy tools available to promote a stronger economic recovery in a context of price stability'. In our opinion, Fed's remaining options include lowering interest rates paid on excess reserve, shifting the composition of the balance sheet to longer maturity, formalizing an inflation target, indicating explicit interest rate ceilings for longer-term Treasury debts (with an ingredient of asset buying) and outright bond purchases (i.e. QE3). While it may not be announced at the conference, the Fed should be in favor of changing the composition of the balance sheet and outright bond purchases.
Rising inflation and a more-divided Fed may have complicated policymakers' monetary decision. However, we believe the 3 dissenters will unlikely hinder the Fed from implementing additional easing measures they are deemed necessary. The single most important factor is still economic developments, i.e. whether employment and inflation are at levels that are consistent with the Fed's dual mandate.
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