My position has always been that in the absence of positive consumer sentiment, all monetary policy is a waste of time. Ben Bernanke's press conference hinged on a new definition of the word "vague," as far as targets and expectations are concerned, while laced with plenty of excuses just in case QE3 doesn't work. The disclaimer is best captured by the phrase "I personally don't think that it's a panacea," while pointing the finger to fiscal policy.
But a portion of the conference delivered the clarity that was needed, and while on the topic of "transmission mechanisms," the Fed chief spoke the magic words: stock prices. I do believe him when he stated that his intent is to help Main Street, not Wall Street, because in addition to preserving whatever is left of the Fed's relevance, his personal legacy is the driving factor behind his decisions. Who wants to be remembered as another Alan Greenspan? The press conference's transcript (pdf) is available at the Fed's website:
Stock prices, many people own stocks directly or indirectly. The issue here is whether or not improving asset prices generally will make people more willing to spend. One of the main concerns that firms have is there is not enough demand, there's not enough people coming and demanding their products. And if people feel that their financial situation is better because their 401(k) looks better for whatever reason, their house is worth more, they are more willing to go out and spend and that's going to provide the demand that firms need in order to be willing to hire and to invest.
Home prices were mentioned, indeed, but stock prices are the focus. The reasoning is quite simple, because home price appreciation is a slow process and hardly able to prod sentiment in the short-term, while higher stock prices should deliver the much needed jolt -- also known as the "wealth effect" -- that can modify consumer sentiment and behavior. In addition, the usual mantra of unemployment, inflation and low rates is nothing more than smoke and mirrors, and has proven to be a fallacy. To the point of consumer sentiment and behavior, Bernanke's speech on August 6, 2012, provided the background, and Bernanke's embrace of behavioral economics is a departure from the norm. I found it amusing, because last year I stated that Fed members should have a degree in psychology.
Continued work on the measurement of economic well-being will likely lead to greater recognition by economists of the contributions of psychology -- an area that has been explored by pioneers like 2002 Nobel laureate Daniel Kahneman. One topic on the frontier of economics and psychology is the neurological basis of human decisions, including decisionmaking under risk and uncertainty, intertemporal choice, and social decisionmaking.
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The chart above provides evidence to support the view that housing is not the Fed's focus. The Mortgage Bankers Association Purchase Index has been flat since mid-2010, and despite the spike in mortgage rates by the beginning of 2011, the subsequent decline from around 5% to 3.5% has not produced any measurable results. How much lower can mortgage rates go?
Bernanke is also attempting to influence consumer sentiment by communicating that rates will stay low through 2015. However, from a behavioral perspective, the message can also be interpreted as an affirmation that economic weakness will prevail. I fail to comprehend how that story will stimulate the consumer. But consumer sentiment is a tricky affair, and the latest University of Michigan reading of 79.2 -- a 4.9 point jump -- was quite interesting. Reason being that, from where I sit and as of late, it appears that this specific reading appears to follow the stock market's gyrations, and I don't know how the population sampling is done as compared to the methodology used by the Conference Board.
To clarify, the Conference Board's index is named "consumer confidence," which is a better definition because one is either confident or not. Thus, three points in time were chosen that coincided with the S&P 500 being valued at 1465 -- June 2000, January 2008, and today -- and then the consumer sentiment numbers were plotted.
The observation is that over time, and on their own, stock prices do not appear to influence consumer sentiment, although one understands that the Fed has now reached the end of the road despite the open-ended nature of QE3. There's much more to sentiment and confidence than driving asset prices up. Despite the fact that Ben Bernanke stated in Jackson Hole that "although the recent recession was unusually deep, I see little evidence of substantial structural change in recent years," as I reported in the article, "The Big Enigma Of Fed Monetary Policy," the truth is that the economic structure has slowly changed over the last 50 years, especially the function of credit markets as economic tools. While I am still writing the paper about "The Delusion of Credit/Debt and Economics," I will advance that the change is not captured by any economic theory or school of thought.
Right on queue, the Federal Reserve Bank of San Francisco published on September 17, 2012 the study "Uncertainty, Unemployment, and Inflation," drawing on consumer sentiment data and pointing out that the "VIX index and consumer uncertainty are countercyclical, rising in recessions and falling in expansions" -- or stock prices and consumer sentiment, again.
We use data from the Thomson Reuters/University of Michigan Surveys of Consumers in the United States and the Confederation of British Industry ((NYSE:CBI)) Industrial Trends Survey in the United Kingdom to measure the perceived uncertainty of consumers and businesses.
The shift in economic thinking and the failure of monetary policy as it stands is the ultimate conclusion, with the estimated effect on unemployment of "at least one percentage point" not accounting for the drop in the labor force participation rate, and making the point useless:
Heightened uncertainty lowers economic activity and inflation, and thus operates like a fall in aggregate demand. During the Great Recession and recovery, we estimate that higher uncertainty has boosted the unemployment rate by at least one percentage point. Policymakers typically try to mitigate uncertainty's adverse economic effects by lowering nominal interest rates. However, in the recession and recovery, nominal interest rates have been near zero and couldn't be lowered further. As a consequence, high uncertainty has been a greater drag on economic activity in the Great Recession and recovery than in previous recessions.
But there are consequences, and the departure from traditional economic theory, which is mostly dogma because the hard wired formulas of yesteryear have been proven to be dismal at best, is also not a "panacea." As small examples, the devaluation of the dollar will have a negative impact on gasoline prices and consumer sentiment by extension, as well as the already fragile economies of countries that are heavily dependent on the export model -- the U.S. is not one of them -- in the midst of a global economic slowdown, not to mention current and upcoming crises. Here's a hint, and I was chastised for it last year: Reverse psychology.
To close, the Reuters article "U.S. earnings now seen falling in third-quarter, first time in three years" published in July of this year, is still holding true as we approach earnings season, and that warning took place 100 S&P 500 points ago. Whether the estimates are fully priced in is anyone's guess, and if the Fed's monetary move fails to prop the markets and consumer sentiment as desired, the fallout will be much bigger, while the Fed's unorthodox tools will be nowhere to be found.