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Bernanke's Speech Adds Little Information To The QE3 Debate

Published 09/03/2012, 02:59 AM
Updated 09/17/2017, 04:35 AM
Fed Chairman Ben Bernanke’s speech at the Jackson Hole forum on Friday added little information regarding whether (and if so, then when) the Fed will commence QE3. On one hand, Bernanke was very clear about his confidence in the effectiveness of the monetary actions in his arsenal (Operation Twist, QE…). On the other hand, he also reiterated that at the moment, the Fed is watching the data carefully and has not made up its mind about its next step.

The “problem” is that things in the US are not bad enough for QE3 to be such an obvious and urgent next step. Data that came out this week was generally encouraging - Case/Shiller and Pending Home Sales both surprised to the upside (reaffirming the apparent recovery in the housing sector, which caused much of the mess in recent years) and GDP and Consumer Spending were revised upwards. Add to that, encouraging data from previous weeks and you understand why Bernanke is not quick to pull the trigger on more monetary action at this time.

The Fed’s (continued) sensitivity to data suggests that the upcoming week holds three important events to watch closely. On Tuesday and Thursday respectively, the ISM Manufacturing and Non-Manufacturing indexes are to be published. For Manufacturing, the consensus on the street is that the almost-breakeven level will persist (that is, just off a print of 50), which means that there is no significant contraction there. For Non-Manufacturing (services), the consensus is for 52.5, which implies a slight expansion of that part of the economy and is about the same as last month’s 52.6.

Then, on Friday, is the employment data - namely, the nonfarm payrolls number (NFP), which provided a positive surprise last month. Expectations are that it will be over 100K this month, as well. We believe that this number will be enough for the Fed to avoid QE3 at the upcoming September 13th FOMC meeting. Therefore, NFP holds a great significance for the USD. By the way, a bet on the state of the US economy can be made by buying currencies of its two main trade partners – Mexico and Canada. These are less crowded bets than the USD itself.

In Europe, there is no big news this week. The only significant happening was a non-happening: Draghi canceled his participation in the Jackson Hole Forum due to his “workload.” Does that mean that we will hear of an actual detailed plan in the upcoming ECB press conference on Thursday? We believe that something must come out of all these signals and hints. More data coming out only reaffirms the poor, and deteriorating, state of the European economy. Now, things are also shakier in France and Germany.

So, what do we expect from the ECB this week? The ECB will likely cut the refinancing rate by 0.25%, thus making liquidly cheaper for borrowing banks. The deposit rate is expected to remain at 0%. In addition, we forecast more help to banks in the form of flexing collateral standards.

More significant than that is the expected agreement on sovereign bond purchases by the ECB. This is a very important issue and needs to be watched carefully. From what we gather from sources familiar with the matter, there is still no agreement on the details of this program (specifically, it seems Germany is still strongly opposing it, with Bundesbank President Weidmann threatening to quit if the program is adopted). But general agreement on this is almost a must at this point, after building high expectations for the market.

A disappointment at this stage will have grave consequences for the likes of Spain and Italy, whose yields declined in recent weeks. Such bond purchases will surely be conditioned on the activation of ESM/EFSF, which means that member states who want their debt bought by the ECB will have to proactively ask for it, and commit to painful reforms and budget cuts in order to be entitled to it.

We have repeatedly discussed the poor state of the British economy and how admirable, yet rather useless policy makers’ actions are there for changing its course. The close ties to Europe simply don’t allow the UK economy to isolate itself from what is happening on the continent. In the coming week we recommend to wait for quite a few PMI (Purchasing Managers Index) numbers.

PMI, a survey of businesses from different sectors, is a very strong proxy for economic activity and is closely watched by the market, as it tends to accurately predict the output of these sectors, an aggregate of the entire economy. The main two PMI numbers to watch are Manufacturing (on Monday) and Services (on Wednesday). Consensus is for prints of 46.3 and 51.6 respectively, so anything below that and you should rush to bet against the GBP, short-term.

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