After a very busy week of data releases and central bank meetings last week, most investors are looking forward to a quiet next few weeks. Unfortunately, given the tenuous nature of a market not driven by sound fundamentals, but largely driven by policy choices, it is crucial for investors to begin looking further into the future.
Most of August will likely be quiet as Europe goes on vacation, Congress is out of session and neither the Fed nor the ECB are meeting. However, in a world starving for financial news, markets will likely let little things (new regulatory decisions, abnormal earnings reports etc.) influence larger trends. This micro focus will come to a halt at the Kansas City Federal Reserve Bank's annual symposium in Jackson Hole, Wyoming near the end of the month.
A market starved for economic policy news will watch and wait with bated breath to see what policy makers pitch at Jackson Hole. Barring major changes to the economic and political outlook over the next few weeks, we should expect to see ECB President Mario Draghi clarify some of his statements from last week by explaining precisely what he wants/needs from European politicians. While this clarity will be welcome, without an overt prior commitment from Germany, the words will continue to ring hollow and lack the commitment to market intervention that investors seek.
Fed Chairman Bernanke will likely stick much closer to the way in which he has utilized the Jackson Hole symposium for the last several years. He will float a new policy idea to gauge reaction and prime market response before implementation. Contrary to much commentary, the new policy idea Bernanke is likely to float is not a third round of large asset purchases known as QE. Instead, Bernanke is likely to propose a way to induce banks to lend more freely.
Given that Bernanke will likely float a new policy idea and Draghi will present greater detail about the ECB's plans at Jackson Hole, September looks like it may be an exciting month for central bankers, but maybe not.
Draghi will face a German vote about the European Stability Mechanism on September 12, but if they vote down the capitalization of the ESM, Draghi's grand plans for further European coordination might be more tenuous than ever. In particular, it will be difficult for the ECB to justify stretching the mandate of the existing European Financial Stability Facility (EFSF) to begin bolstering European bond markets if the ESM is not firmly on the way. It will be an even greater challenge if Germany is the roadblock. So, while it is reasonable to expect ECB action when everyone returns from vacation in September, it should not be seen as a foregone conclusion by the markets.
The Fed's timeline is even hairier than the ECB's. The Fed essentially has two possible windows in which to start a new program. If, as expected, they float a new idea at Jackson Hole, they could pursue a new stimulative policy as early as the September 12-13 FOMC meeting. However, this is less than 2 months before the November 6 election. In addition to opening the Fed up to criticism about political involvement, it also creates a variety of potential policy pitfalls.
If the Fed announces a new policy to stimulate lending in September:
- They open themselves up to significant political criticism about trying to bolster markets to engineer an Obama reelection since Romney has openly stated that he would not reappoint Bernanke.
- They lose the natural justification that they are intervening in the markets after the expiration of their last stimulative policy, Twist (set to expire in December).
- They reduce pressure on Congress to address the fiscal cliff before the election or at least before year-end.
- They run the risk of setting up a new joint program with Treasury that might not be able to exist in January if a new administration takes office. This will not instill the desired confidence in the markets, but any extension of the Fed's low rate pledge beyond the end of Bernanke's term should be viewed with similar skepticism.
The ECB needs to get its political ducks in a row during this August lull if they intend to engage in new stimulative policies during September, as they have indicated. Such coordination is not guaranteed and markets should not come to expect huge market interventions by the ECB. In the U.S. the Fed is significantly more powerful than the ECB, and with the unemployment rate having nominally risen from 8.2 to 8.3 percent (really from 8.216 to 8.253 percent), they have some cover to engage markets further. However, the pitfalls ahead indicate that barring additional market weakness, the Fed might be politically best off waiting until December or January to jump into a new market stimulation policy. So, enjoy what should be a quiet market for the next couple weeks before all eyes turn to the Teton Mountains of Wyoming for indications about the policy ahead throughout the rest of 2012.