Thursday, August 30, 2012

Some thoughts before Bernanke's speech

Tomorrow morning at 10 AM EST anyone who is in any way connected with global financial markets will be at the edge of their seats as Fed President Ben Bernanke gives his annual speech at the Jackson Hole conference in Jackson Hole, Wyoming. 

The market had a down day in anticipation of the speech as it seemed to become apparent to traders and investors that Bernanke will not be announcing another round of QE (at least not yet). 

Yet, I do think the market is overreacting to what it anticipates will be a disappointing speech.  If there's one thing Mr. Bernanke does not want to do it's to upset global financial markets.  Expect some hints and clues regarding further accommodation.  Particularly, the FED already knows that bond buying is pushing on a string when it comes to impacting employment.  Indeed, many argue (as do I) that structural unemployment is now higher due largely to demographics (baby boomers leaving the job market).  But Bernanke must be given credit for the turn in the housing market. Sub 4% mortgage rates are the result of the FED anchoring the long end of the yield curve at abnormally low interest rates.  The present strength in home building stocks is testimony to the Fed's success in this area of the economy.

Expect not a bond buying program but a hint of a plan to entice banks to ease credit standards so as to spur more commercial lending.  The intent would be to get small business loans going in the hope that with more lending, more hiring will eventually follow. 

The Fed is trying to do what the government should be doing.  Instead, the government, led by the Obama administration, prefers to saddle corporate America and small business with Obamacare and higher taxes.

How the market will react to the speech is any one's guess after the sell off today.  I'm expecting more downside but I've positioned myself to benefit which ever way the market goes.

The only drawback to promoting more lending is the real possibility that the trillions of dollars on bank balance sheets which have not been used since 2009 will now get into circulation and inordinate inflationary pressures will ensue in the national economy.

Here's the latest chart from the St. Louis Federal Reserve on M2 Velocity of money:



Velocity is a ratio of nominal GDP to a measure of the money supply. It can be thought of as the rate of turnover in the money supply--that is, the number of times one dollar is used to purchase final goods and services included in GDP.  M2 is the most popular measure of money stock in circulation.

If the Fed moves forward with attempting to stimulate lending in the national economy and they are as successful as they were in the housing market the velocity of money is bound to increase.  As the slope on the chart above flattens and then turns up it will be necessary for the Fed to immediately start withdrawing liquidity in the system via repos.  But will they be able to withdraw enough in a timely manner before the inflation genie gets out of the bottle?

Stay tuned ...