Another quiet day, this one starting out optimistically as equities rose on reports that OPEC will raise its official output targets in order to make up for lost Libyan oil production. That pressured energy quotes, but not as much as you might think. The problem in the oil markets, after all, isn’t that the members of OPEC have restrained themselves from selling too much oil and caused a shortage. The members of OPEC are already producing 2mbpd (million barrels per day) above the official output quotas. The problem in the oil markets is that oil producers globally are near the practical output ceiling, especially if – as many believe – the Saudis’ assertions that they have substantial unutilized capacity turns out to be untrue.
The pressure on oil markets thus wasn’t particularly strong, since “sources” are saying OPEC’s quotas will rise about 1.5mbpd ... less, in other words, than they are already evidently producing.
More significant, but less specific to today, is a growing constituency of policymakers who are arguing for a three percent “surcharge” on bank capital ratios. You can tell that there is a growing sense that this is bluster, because the Nasdaq Bank Index outperformed the market today by rising 0.3%. An increase in the required capital ratios of three percent is just another dagger in the future profitability of banks, if it happens. It lowers leverage, which is one element of the DuPont model of ROE. It is also going to make it even harder for the economy to recover. Jamie Dimon of JPMorgan (JPM) put it well yesterday when he said, “Why would we own mortgages if you can own them at 7% capital and I have to own them at 10%?” Fewer owners of mortgages means higher rates for mortgages, folks.
So the market was doing well until late in the day when Chairman Bernanke expressed his opinion, in a speech in Atlanta, that the Fed should maintain stimulus in continued support of a “frustratingly slow” recovery. With the Unemployment Rate rising recently, the Chairman pointed to it again and said “until we see a sustained period of stronger job creation, we cannot consider the recovery to be truly established.”
This is literally chapter and verse. He said exactly the same thing in February to the National Press Club and again in March in testimony to Congress. The difference this time, if there is any, is that QE2 is just about done, whereas at the time of those last comments there were still many billions to come. Also, the economy at the time of those earlier quotes was improving, while now it is softening.
So what does it mean when you have shot all your bullets and there are just as many of the enemy standing there? To some people, it means it is time to reload. To others, it means it is time to try something different (like, maybe, running). But the market took Bernanke’s comments to mean he prefers to stand there and wait to see if the enemy starts to fall down dead of its own accord, and this managed to turn a positive day into a slightly negative one.
It isn’t that everyone was expecting a QE3, and that the third time would be the charm. In fact, I think most professional investors understand that a QE3 is quite unlikely absent another huge debacle (and in that case, it isn’t even clear that the Fed would be gung-ho for QE3 since such an event would likely help Ron Paul’s campaign to end the Fed as being ineffectual). But in this context, investors would like to see the Chairman exuding confidence that the plan is working and that we don’t need QE3. He doesn’t have to say that; he just needs to use more positive language and people will feel better.
Now, if the plan is to make sure that the coming inflation remains unanticipated (if you missed it then see yesterday’s comment), he’s going about it the right way.
His arguments were uncharacteristically lame. He spent part of his speech explaining how headline inflation will ebb if commodity prices just stop going up – but policymakers aren’t supposed to care about headline inflation, so it is odd to be focusing cheerfully on it when core inflation is rising steadily. He disputed that the profligate monetary policy is causing the dollar’s weakness (and perforce the correlated strength in commodities), with the logically-vacuous observation that “many factors other than monetary policy affect the value of the dollar.” This is true. It is also true that many factors other than the season of the year affect how warm it is outside, but that doesn’t imply that “summer” doesn’t matter.
Bernanke is smarter than that. He’s not infallible as he seems to think he is, but he’s smart enough not to make weak arguments when stronger arguments are available. Maybe he’s just bored and can’t be bothered to sharpen his rhetoric. Or maybe he’s just mailing it in – he only has two and a half more years as Chairman, after all!
Wednesday is another day with sparse scheduled data. The Beige Book is due at 2:00ET, but this is unlikely to move markets. Watch the dollar, which is around 1 point on the DXY away from the post-2008 low set just a month ago. Former buyers of that bounce will become sellers of the break.