Despite the unambiguous language adopted in the latest set of FOMC Minutes, a remarkable degree of scepticism has emerged concerning Fed Chairman Bernanke’s message to be delivered as the keynote address at the annual symposium of the Kansas City Fed at Jackson Hole. In those Minutes, many members of the FOMC felt that further monetary policy action would be required fairly soon unless there was a ‘substantial and sustainable’ improvement in the economy. The Minutes also declared that another large-scale program of asset purchases could provide the recovery with some additional impetus. With the economy not displaying any signs of this ‘sustainable’ improvement since the last meeting, failure by the FOMC to deliver a further significant burst of QE when it meets on September 13th would be both very surprising and do significant damage to its credibility.
Some market participants are suggesting that the Fed will simply decide to lengthen its extended period commitment out past late 2014, and that it will pledge to maintain a highly expansionary monetary policy stance until well after recovery has taken hold. Indeed, the Minutes themselves claimed that such an approach might be particularly effective although, given the views expressed above regarding more asset purchases, it is unlikely that such a commitment would be nearly enough for the markets. The 2yr yield for example is already trading in line with the funds rate, so the front end is already fully discounting two years of zero change in Fed interest rate policy.
As always, the Fed’s über-dove, Chicago Fed President Evans, is pressing hard. He wants the Fed to sign up for unlimited QE, with the focus this time on mortgage-backed securities. Evans believes that the Fed is not delivering on its twin mandate, namely to promote employment and to ensure steady low inflation.
With the economic backdrop in both Europe and China still problematic, and American growth already being adversely affected by the prospect of a fiscal cliff early next year, Fed policy-makers surely must appreciate the urgency of the situation. The Fed Chairman has shown in the past that he does not hesitate when the circumstances demand bold action. Furthermore, Mitt Romney has already intimated that he will not re-appoint the Fed Chairman when his term ends in early 2014. In contrast, if President Obama is elected he most likely would re-appoint Bernanke. If only for political reasons, Bernanke could be excused for opting for QE3 sooner rather than later.