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What’s A Central Banker To Do?
 

What’s A Central Banker To Do?

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Fed Camp. The Kansas City Fed’s annual monetary policy symposium in Jackson Hole, Wyoming is attended by central bankers from around the world. For U.S. investors, the focus will be on Bernanke’s ...

Fed Camp. The Kansas City Fed’s annual monetary policy symposium in Jackson Hole, Wyoming is attended by central bankers from around the world. For U.S. investors, the focus will be on Bernanke’s speech on Friday (August 26). Many market participants are hoping for a repeat of last year, when the Fed Chairman signaled the possibility of a second round of asset purchases (what most people call “QE2”). However, while the August 9 Federal Open Market Committee indicated that its members were discussing a range of policy tools to promote growth, the FOMC is unlikely to pull the trigger on another round of asset purchases anytime soon. The main reason for that reluctance is the inflation backdrop.

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    What’s A Central Banker To Do? What’s A Central Banker To Do? Document Transcript

    • 6363 Woodway Dr Suite 870 Houston, TX 77057 Phone: 713-244-3030 Fax: 713-513-5669 Securities are offered through RAYMOND JAMES FINANCIAL SERVICES, INC. Member FINRA / SIPC Green Financial Group An Independent FirmWeekly Commentary by Dr. Scott BrownWhat’s A Central Banker To Do?August 22 – 26, 2011Fed Camp. The Kansas City Fed’s annual monetary policy symposium in Jackson Hole, Wyoming is attendedby central bankers from around the world. For U.S. investors, the focus will be on Bernanke’s speech onFriday (August 26). Many market participants are hoping for a repeat of last year, when the Fed Chairmansignaled the possibility of a second round of asset purchases (what most people call “QE2”). However, whilethe August 9 Federal Open Market Committee indicated that its members were discussing a range of policytools to promote growth, the FOMC is unlikely to pull the trigger on another round of asset purchasesanytime soon. The main reason for that reluctance is the inflation backdrop.
    • The data reports over the last several weeks suggest a continued, but subpar, economic recovery – not arecession. At best, growth is expected to be enough to absorb the growth in the working-age population, butwill fall short of what’s needed to make up much of the ground lost in the labor market during the downturn.At worst, we enter a new recession. We continue to face a number of economic headwinds and the risks to thegrowth outlook are tilted to the downside. Models of recession probabilities, as well as personal judgment,suggest that the odds of entering a recession within the next 12 months may be 30% to 35% – not likely, buttoo high for comfort.Unlike a year ago, when the appearance of an economic soft patch was accompanied by falling inflation anddeclining inflation expectations, the recent inflation experience has been different. The core CPI has risen ata 2.5% annual rate in the first seven months of 2011 – above the Fed’s comfort range (1.5% to 2.0%), but not“runaway” inflation. Commodity price pressures have moderated, but some firms are trying to pass along thehigher costs that were run up over the last several months. Wage pressures remain moderate. Inflationexpectations appear to be well-anchored. Breakeven inflation, the spread between yields on inflation-adjusted and fixed-rate Treasuries, has dropped in the last few weeks, but that decline partly reflects a flightto safety in fixed-rate Treasuries (there’s a time-varying liquidity premium built into the price of fixed-rateTreasuries, which means that breakeven inflation rates are not necessarily the same as inflationexpectations). The Atlanta Fed has a model of deflation probabilities (the likelihood that the reference CPIwill be lower in April 2015 than it was in April 2010). The probability of deflation was relatively high lastyear, but began to fall as the Fed indicated another round of asset purchases. Currently, the odds of deflationremain low.
    • So why would the Fed want to undertake another round of asset purchases? In setting monetary policy, theFed has to be forward thinking. One could argue that the economy will continue to weaken and that the oddsof deflation will increase, but that seems like a bit of a stretch right now – a possibility, not the most likelyoutcome. In addition, this isn’t Bernanke’s decision alone. He has to convince a majority on the FOMC.In his monetary policy testimony in July, Bernanke highlighted a number of steps the Fed could takeif “economic weakness proves to be more persistent than expected and deflationary risks reemerge.” One isto provide more explicit guidance about the period over which the federal funds rate will remain low (as wasdone at the August 9 policy meeting). The Fed could also increase its asset purchases or lengthen thematurity of securities held in its portfolio. It could also lower the interest rate that it pays on bank reserves.However, the use of any of these tools is predicated on the Fed seeing a renewed risk of deflation.Market participants expect something from Bernanke on Friday, but there’s a good chance that they’ll bedisappointed.