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Fed and ECB: No Action As Expected!

  • Written by Syndicated Publisher No Comments Comments
    August 3, 2012

    eurocrisis2The last couple of days have been a disappointment to the litany of media commentators and analysts who have been sure that the Fed, and the ECB, would surely launch further stimulus programs to boost the markets. However, as we have reported many times in the past, but most recently here, further stimulative programs at this time were unlikely and setting the markets up for disappointment. Today, the markets are disappointed.

    The Federal Open Market Committee announcement on Wednesday left the markets on edge as the Fed lowered its economic assessment stating that “June suggests that economic activity decelerated somewhat…” and that it will continue to closely monitor incoming information on economic and financial developments and will provide additional accommodation as needed.” That statement replaced the previous language of “The committee is prepared to take further action as appropriate.”

    Immediately, all the media, analysts and economists, who had wrongly forecast “imminent QE” began to spin the Fed communiqué as a sign that the Fed is closer to doing something. However, this group of individuals has been seeing “imminent QE” in every Fed announcement for over a year. Even the supposed Fed mouthpiece Jon Hilsenrath at the WSJ who has been moving markets as of late with his prognostications of Fed action on Wednesday is today spinning the Fed announcement again: Fed Gives Stronger Signals of Action by Jon Hilsenrath & Kristina Peterson

    The problem with these individuals, who have continued to hope for more stimulative action to boost the financial markets, is they are trying to twist “Fed speak” into another clue for more easing ahead. Jon Hilsenrath penned: “In an uncharacteristically strong statement, the Fed said it will ‘closely monitor’ the economy and ‘will provide additional accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions.’ Translation: The Fed will move if growth and employment don’t pick up soon on their own.

    This is a reach even by Hilsenrath’s standards as Bernanke has used this phrase often enough before without it being “code” for anything in particular. For example, in a June 2011 speech on the economic outlook he said:

    “Thus, the Federal Reserve will continue to closely monitor the evolution of inflation and inflation expectations and will take whatever actions are necessary to keep inflation well controlled.”

    In testimony to Congress in October 2011 he said:

    “The Committee will continue to closely monitor economic developments and is prepared to take further action as appropriate to promote a stronger economic recovery in a context of price stability.”

    All of which means that, if this were a “coded signal” for imminent action then it was just a bit too coded. With the continued deterioration in Europe everyone is on high alert for coordinated action by central banks and it’s highly unlikely that the Fed is trying to send out advanced warning.

    Broken Transmission System

    The Fed is acutely aware of the deteriorating economic and employment problem, however, Bernanke is also just as aware that Q.E. will not boost employment, or the economy, because fiscal policy is broken. At recent FOMC meetings and Capitol Hill Testimony he has made clear that monetary tools are limited in their effectiveness and that it is up to Congress to bring fiscal policy tools to bear to start moving the economy in the right direction.

    Unfortunately, as Senator Schumer correctly stated: “Given the political realities, particularly in this election year, I’m afraid the Fed’s the only game in town. I would urge you to take whatever actions you think would be most helpful in supporting a stronger economic recovery. The bottom line is very simple, we’re not going to get the fiscal relief we want at least over the next short while. Perhaps after November we will. Mr. Chairman, get to work.”

    As stated above, Bernanke has been quite clear in past testimony, that stimulative programs have had a diminishing rate of return on both the markets and the economy. His response to Schumer was clear: “The complication, of course, is we are dealing with less conventional tools and we have to make assessments about their efficacy and the costs and risks may be associated with them.” This is a very key statement.

    As we discussed yesterday – “the problem with the stimulative measures that have been applied over the last three years by the Fed is that they have acted to drag forward future demand. That ‘demand pull’ successfully pulled, and kept, the economy out of a deeper recession since 2009, however, at the conclusion of each of these programs the vacuum created by that ‘demand pull’ was immediately felt through the economy. There is clear evidence that there is still insufficient demand to stimulate, and sustain, organic economic growth. While Q.E. will drag forward future demand in the short term it fails to spur organic economic growth as the dollars fail to move through the economy. Furthermore, the Fed has learned that Q.E. programs boost inflationary pressures which further impairs economic growth. With soaring grain and gasoline prices, which usually decline in July, and the markets up strongly for the year – there is little wiggle room for the Fed to act.” This is specifically why the Fed is very likely to save further Q.E. actions to offset a systemic event that is daily becoming more of a “when” rather than an “if.”

    ECB – More Promises And No Action

    As expected Mario Draghi, head of the ECB, announced nothing on Thursday after promising the markets last week that he would “do whatever is necessary to save the Euro” which sent markets surging higher. We have said more than once lately that “talk is cheap” and that Mario has now put himself into a corner to act.

    We stated that it was highly unlikely that the ECB would move further without support from Germany since they are the principal “paymaster” in the Eurozone. This leaves Draghi in a bind as the EFSF only has roughly $200 billion in funding left and the ESM has yet to be ratified. Germany is not due to ratify the ESM until September – if ever – and further action could be delayed until early 2013. This leaves the markets and the Eurozone at a great degree of risk.

    Here are the highlights from Draghi’s speech:

    • DRAGHI SAYS UNDERLYING PACE OF MONETARY EXPANSION IS SUBDUED
    • ECB’S DRAGHI SAYS INFLATION EXPECTATIONS ARE FIRMLY ANCHORED
    • DRAGHI SAYS INFLATION SHOULD DECLINE FURTHER TO BELOW 2% IN ’13
    • DRAGHI SAYS EURO-REGION GROWTH REMAINS WEAK
    • DRAGHI SAYS HEIGHTENED UNCERTAINTY WEIGHING ON EURO SENTIMENT
    • DRAGHI SAYS EXCEPTIONALLY HIGH RISK PREMIUM IN SEVERAL NATIONS
    • DRAGHI SAYS RISK PREMIUM NEED TO BE ADDRESSED
    • DRAGHI SAYS EURO IS IRREVERSIBLE
    • DRAGHI SAYS HIGH YIELDS ARE UNACCEPTABLE
    • DRAGHI SAYS POLICY MAKERS NEED TO PUSH AHEAD WITH CONSOLIDATION

    The last four statements had journalists penning articles that “help is on the way,” however, I urge caution in making such assumptions as Draghi then stated the obvious problem:

    • DRAGHI SAYS GOVERNMENTS MUST STAND READY TO ACTIVATE EFSF

    As stated above there is not enough funding in the EFSF to resolve much, if any, of the problems plaguing Spain and Italy. Furthermore, Germany is not likely to approve further direct intervention into Spain outside the €100 billion commitment that Spain has yet to apply for.

    • DRAGHI SAYS ECB MAY UNDERTAKE OUTRIGHT OPEN MARKET OPERATIONS.
    • DRAGHI SAYS ECB MAY TAKE FURTHER NON-STANDARD MEASURES
    • DRAGHI SAYS OVER COMING WEEKS ECB WILL DESIGN MODALITIES

    Furthermore, during the Q&A session, Draghi stated that the “THE ECB CAN NOT REPLACE GOVERNMENTS. UP TO GOVERNMENTS TO ASK FOR INTERVENTION.” The problem for governments is that if they ask for intervention they know that Germany will demand stringent austerity measures in exchange for intervention which is a “hangman’s noose” for the politician that accepts measures that will plunge the countries economy into a deep recession.

    The ECB has already tried two LTRO programs that had negligible short term effects. When asked if further bond buying was a possibility he responded that: “any bond buying will be focused on the short part of the yield curve.” This means that long term refinancing operations are most likely not on the table.

    While Draghi stated last week that he was ready to act with the ECB’s mandate – he reversed course today stating that: “…even if we were ready to act now, would not have grounds to do so.” As stated before – even though Germany only has 3 seats on the ECB they effectively control it. Germany has been adamant in recent days that they would not approve either a banking license for the ESM or further bond buying before the approval of the ESM in September.

    This leaves Draghi and the ECB in a dangerous position of losing credibility in the days and weeks ahead. Without Germany on board there is little action that can feasibly be undertaken. This leaves the markets exposed as the realization sets in that further action may not be coming soon.

    Images: Flickr (licence attribution)

    About The Author

    Lance Roberts – Host of Streettalk Live

    lance robertsAfter having been in the investing world for more than 25 years from private banking and investment management to private and venture capital; Lance has pretty much “been there and done that” at one point or another. His common sense approach has appealed to audiences for over a decade and continues to grow each and every week.

    Lance is also the Chief Editor of the X-Report, a weekly subscriber based-newsletter that is distributed nationwide. The newsletter covers economic, political and market topics as they relate to the management portfolios. A daily financial blog, audio and video’s also keep members informed of the day’s events and how it impacts your money.

    Lance’s investment strategies and knowledge have been featured on Fox 26, CNBC, Fox Business News and Fox News. He has been quoted by a litany of publications from the Wall Street Journal, Reuters, The Washington Post all the way to TheStreet.com as well as on several of the nation’s biggest financial blogs such as the Pragmatic Capitalist, Zero Hedge and Seeking Alpha.
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