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August  24th, 2012

The key event for global markets in the upcoming week is Federal Reserve Chair Bernanke’s August 31 speech at the Kansas City Fed’s symposium in Jackson Hole, Wyoming. Released August 22, dovish minutes from the last FOMC meeting restored much if not all of dealers’ expectations that additional monetary policy stimulus in the form of new round of large-scale asset purchases (i.e., QE3) is right around the corner. Despite widespread agreement that the Fed is feeling strongly accommodative, there remain tremendous differences between dealers’ expectations of what comes out of the Jackson Hole gathering and more importantly from the September 13 FOMC policy statement.


BMO Capital Markets remarked, “The Chairman’s speech titled “The Changing Policy Landscape” offers a broad canvas to paint his views on the economy at a venue previously used to hint at policy changes (QE2 in 2010 and Twist in 2011). While Bernanke might not reveal whether he is among the crowd of ‘many’ policymakers that on August 1 favored further easing soon, including QE3, if the expansion failed to improve substantially, he could indicate which options are at the top of his toolbox should the wheels on the recovery wagon continue to wobble.” For BMO the predominant options include: extending guidance on initial rate hikes to 2015, possibly trimming rates paid on excess reserves, and another maturity extension program (“twist”) involving the Fed’s nearly $1 trillion portfolio of Agency debt and MBS. “Deeper in the Fed’s toolbox is the QE3 mallet, a more effective tool for nailing down long-term rates, and one we believe will be used around the turn of the year. Also useful could be a “funding for lending” drill (providing cheap credit to banks provided they lend to businesses and households, as recently launched by the BoE) to stir credit creation.”


While it admits that the statement and minutes of the August FOMC meeting had a clear dovish tone, Barclays Interest Rates Research does not believe Jackson Hole will contain a strong signal. Instead the dealer believes the stronger data flow and improvement in financial markets will lead the Fed to refrain from initiating QE3 at its September meeting. “The FOMC’s mindset is likely to crystallize only after the September payrolls report. While we maintain our view that the Fed will not initiate QE3 in September, there is a chance that it will alter its forward guidance, perhaps by pushing forward the ‘late 2014’ language. At the August meeting, ‘many members’ expressed support for extending forward guidance, but the Committee did not agree on how best do to so and agreed to defer a decision until September. Given the tone of the minutes, as well as the improvement in data since, a change in forward guidance could well end up being the agreed compromise. The main questions the Fed has to answer are: do the benefits of further accommodation outweigh the costs, and is it better to act in advance of a possible fiscal drag or is it better to keep your power dry? We do not think the Chairman will be ready to answer these questions next week.”


Economists at Bank of America Merrill Lynch Economics expect Bernanke use the symposium to “affirm the Fed’s dovish bias, defend the usefulness of additional easing, and offer more details on policy options.” In their U.S. Economic Weekly published late Thursday BoAML remarked, “In our view, despite the better data, the Fed is very likely to ease further at its September 12-13 meeting. The über-dovish FOMC minutes confirm our Fed call. At their next meeting we expect them to extend forward guidance to ‘late 2015.’ We also see about a 50% probability of QE3 in September and about an 80% chance by year end.” While Oddo Securities feels the FOMC minutes reveal that the Committee’s bias is clearly toward further accommodation it countered, “What the Fed lacks at present is less the resolve to act than the appropriate means to really contribute to reducing unemployment and supporting economic activity.”


Exane BNP Paribas Global Economics charges all developed market central banks to do more to promote demand. “With growth slowing across the global economy, it will be up to the new ‘lords’ of finance to ease further monetary policy as market expectations have begun to build up. Despite the better-than-expected macro data, the underlying pace of US economic growth still remains too weak to produce a meaningful improvement in the labor market. Against a backdrop of easing core inflation, we maintain our longstanding view that the Fed will purchase MBS in H2, with our bets on the September 12/13th meeting.”


Canada’s Desjardins Capital Markets believes, “A modest (US$100–200 bln) QE3 program on September 13 is now a 90% probability, in our opinion, as ‘many’ Fed members now want the Fed to ‘do something…soon’, as opposed to ‘a few’ at the previous meeting. Another weak (less than 100,000) jobs report would make QE3 a sure thing, while a 200,000+ jobs report may cause another delay.” In the view of Deutsche Bank Global Markets Research, “The Chairman may not commit to any particular policy option in his Jackson Hole speech, though he will make clear that the Committee maintains an easing bias. If August payroll gains are below +100k, policymakers may opt for a more aggressive response in September. In the meantime, we expect them to enact a “verbal easing” by extending the guidance on the fed funds exit from late 2014 to late 2015. In turn, we have pushed out our expectations for the first Fed funds rate increase from late 2013 to late 2014. It is important to keep in mind that at the time of the last FOMC meeting the three-month moving average on nonfarm payrolls was +75k, consumer spending had declined for three consecutive months and the manufacturing ISM had fallen below 50 for two consecutive months—the first sub-50 readings since June-July 2009 when the recovery was just beginning. Thus, given the tone of the data at the end of Q2, meeting participants fretted downside risks to their near-term growth forecasts. The tone of the upcoming economic data will influence the degree of accommodation implemented at the September meeting.”


In their Weekly Forex newsletter, Natixis Economic Research wrote Friday, “While it is likely there will be a QE3, the timing is hard to predict. Bernanke probably reiterate that he needs a little more time before acting, which means a decision is unlikely when the Fed meets in September. A dovish tone would be likely to weigh on the greenback, but the latest US macroeconomic figures will be also be important, particularly if they improve further, lessening the urgency for further quantitative easing. All in all therefore, the US still has a little downside in the short term.” Natixis advised that in the days before the symposium, “High beta currencies should be rather upbeat, notably Scandinavian currencies that continue to be bolstered by sound economic fundamentals. For the coming week, we are bearish on the US dollar (EUR/USD could test 1.2625), neutral on the Japanese yen, and bullish on the Canadian, Australian and New Zealand dollars as well as the Swedish krona and Norwegian krone.”


The Economics team at Societe Generale Cross Asset Research found nothing in the last FOMC minutes to alter their current expectation that additional quantitative easing measures will be announced in mid September. Quoting from the minutes, SG emphasized the phrasing, “Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.” SG likewise felt that, “Despite comparatively upbeat figures on job creation and retail sales in July, that condition is a long way from being met.”


Bernanke doesn’t take to the podium at Jackson Hole until 10:00ET Friday, after the release of several high-value data points in the week. Wednesday’s event calendar could steal some of Friday’s thunder, as it has the second look at Q2 GDP growth as well as the Beige Book, the collection of anecdotes from business contacts across the 12 Federal Reserve Districts that will guide policy discussions at the September 12-13 FOMC meeting.


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