Stocks Up 17% Since Bernanke Disclosed QE2 Disarms Fed Critics
By - Dec 17, 2010 12:00 AM ET
Ben S. Bernanke, chairman of the U.S. Federal Reserve. Photographer: Joshua Roberts/Bloomberg
Dec. 16 (Bloomberg) -- John Taylor, a professor of economics at Stanford University and a former Treasury undersecretary, discusses Federal Reserve monetary policy and the outlook for U.S. economic recovery. Taylor speaks with Tom Keene on Bloomberg Television's "Surveillance Midday." (Source: Bloomberg)
Republican leaders in Congress say they have “deep concerns” about Ben S. Bernanke’s second round of quantitative easing. The U.S. stock and credit markets don’t share those reservations.
The Standard & Poor’s 500 Index has climbed 17 percent since the Federal Reserve chairman first indicated on Aug. 27 that the central bank might buy more securities to boost the economy. Junk bonds rallied, with the extra yield that investors demand to own the securities instead of government debt shrinking to 5.45 percentage points yesterday from 6.81 points, according to Bank of America Merrill Lynch index data.
“It has been successful,” Peter Hooper, chief economist at Deutsche Bank Securities Inc. in New York, said of Bernanke’s policy of pumping money into the financial system, dubbed QE2. “It’s contributed to the rally in the stock market” and has “been important in reducing substantially the downside risk of deflation.”
Economic reports signal the recovery is gaining strength. A bigger-than-projected increase in retail sales in November prompted Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, to raise his outlook for fourth-quarter consumer spending. Industrial production in November also exceeded forecasts, and a gauge of consumer confidence rose to a six-month high in December.
The data, coupled with the prospect Congress will pass an $858 billion plan to extend Bush-era tax cuts, has prompted economists to boost their estimates for growth next year. The economy will expand by 2.6 percent in 2011, according to the median forecast in a Bloomberg News survey of 66 economists this month, up from a 2.5 percent prediction in November.
Confidence Grows
“As people get more confident about the economy, money is coming into the stock market,” saidJeremy Siegel, a finance professor at the University of Pennsylvania’s Wharton School in Philadelphia. “The most important way quantitative easing works is the provision of liquidity.”
New York Fed President William Dudley said Oct. 1 that asset purchases would reduce borrowing costs and support the value of homes and stocks, leaving consumers with more money to spend and lowering the cost of capital for businesses.
The extra yield investors demand to own investment-grade corporate bonds instead of government debt narrowed to 1.7 percentage points yesterday from 1.91 percentage points on Aug. 27, Bank of America Merrill Lynch index data show.
“Markets in general have moved in a growth-friendly direction,” said Dean Maki, chief U.S. economist at Barclays Capital in New York.
Contrast With Summer
The latest economic data are in contrast to a drumbeat of negative economic reports last summer, including declines in home sales and payrolls, that prompted economists such as Harvard University’s Martin Feldstein to warn that the risks of a renewed recession were rising.
On Aug. 27, Bernanke said the Fed “will do all that it can” to support the recovery and signaled it was ready to start a second round of securities purchases, in addition to the $1.7 trillion it bought through last March to pull the nation out of the worst recession since the Great Depression.
The Fed’s Nov. 3 announcement that it will buy $600 billion of Treasuries through June came a day after Congressional elections gave Republicans a majority of seats in the House of Representatives.
‘Dangerous Experiment’
Sarah Palin, the 2008 vice presidential nominee who says she’s considering a run for president in 2012, wrote to the Wall Street Journal last month, saying “it’s time for us to ‘refudiate’ the notion that this dangerous experiment in printing $600 billion out of thin air, with nothing to back it up, will magically fix economic problems.”
Representative John Boehner of Ohio, nominated to be House speaker, and three other Republican leaders sent Bernanke a letter Nov. 17 expressing “our deep concerns over the recent announcement that the Federal Reserve will purchase additional U.S. Treasury bonds.”
“Such a measure introduces significant uncertainty regarding the future strength of the dollar and could result both in hard-to-control, long-term inflation and potentially generate artificial asset bubbles that could cause further economic disruptions,” they wrote.
Since then, the dollar has gained about 1.2 percent against the currencies of six major trading partners as measured by IntercontinentalExchange Inc.’s Dollar Index as of 5 p.m. in New York. The dollar is down 3.5 percent since Aug. 27.
The cost of living increased 0.1 percent in November, less than forecast, indicating higher prices for commodities aren’t filtering through into other goods and services, according to a Dec. 15 Labor Department report.
Seen as Favorable
“We don’t expect a rapid move higher in inflation anytime soon,” said Maki, who was the No. 2 forecaster overall for the U.S. economy in the two-year period ended on Sept. 30, according to data compiled by Bloomberg. “What we’re expecting is a very gradual upward trend that is likely to be seen by the Fed as favorable.”
Policy makers are concerned that too-low inflation will push up borrowing costs and increase the risk of deflation, or a debilitating decline in prices that boosts debt and reduces wages and profits.
The Fed’s policies have led inflation expectations to increase. The breakeven rate for 10-year Treasury Inflation Protected Securities, the yield difference between the inflation-linked debt and comparable maturity Treasuries, has risen to 2.31 percentage points from 1.63 percentage points on Aug. 27, according to data compiled by Bloomberg. The rate is a measure of the outlook for consumer prices over the life of the securities.
Diminished Risk
“Because the Fed is acting, I would say the risk is pretty low” of deflation, Bernanke said in an interview with CBS Corp.’s “60 Minutes” program broadcast Dec. 5. “But if the Fed did not act, then given how much inflation has come down since the beginning of the recession, I think it would be a more serious concern.”
Not every indicator is going Bernanke’s way. Payrolls in November increased by 39,000 jobs, less than the most pessimistic forecast in a Bloomberg News survey of economists, and the unemployment rate rose to 9.8 percent from 9.6 percent.
The pace of economic growth is “insufficient to bring down unemployment,” the Federal Open Market Committee said this week as it affirmed its bond-buying plan and renewed a pledge for an “extended period” of low interest rates.
An increase in Treasury bond yields has provided fodder to critics such as Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut.
‘Dismal Failure’
“Their effort to achieve the stated objective of pressing long-term yields lower has been a dismal failure,” Stanley said in a Dec. 14 report. The yield on the benchmark 10-year Treasury note has climbed to 3.42 percent from 2.64 percent on Aug. 27, according to data compiled by Bloomberg.
Kevin Hassett, director of economic-policy studies at the American Enterprise Institute in Washington and a former Fed economist, said the central bank can’t take sole credit for the stock rally, which he said was caused by “a slew of slightly better economic data.”
Hassett, one of 23 mainly Republican academics and former policy makers who signed a letter last month to Bernanke telling him to arrest his expansion of monetary stimulus because it will cause a surge in inflation, also questioned whether stock gains will spur consumer spending through the so-called wealth effect.
While consumers’ stock investments have gained in value, “their bonds are going down,” said Hassett, who is also a columnist for Bloomberg News.
Too Early to Judge
Former Fed Governor Lyle Gramley said it’s “too early to make any definitive judgment” on the Fed’s bond purchases.
“I don’t know how you parse out the effects of QE2 given the changes in the environment,” including the sovereign-debt crisis in Europe and prospects for an extension of tax cuts in the U.S., said Gramley, senior adviser at Potomac Research Group in Washington.
Others say the rise in bond yields is a positive signal that reflects the outlook for faster economic growth and rising inflation expectations.
Fed asset purchases are keeping yields lower than they otherwise would be, Citigroup Inc. analysts led by Robert DiClemente said in a Dec. 10 report. At 3.42 percent, the yield on the 10-year Treasury note is below its 10-year average of about 4.16 percent, Bloomberg data show.
‘Bad Mistake’
“Looking only at the long-term rate is a bad mistake on those interpreting this policy” because quantitative easing works by increasing liquidity, University of Pennsylvania’s Siegel said.
Siegel pointed to the rise in commodity prices as another sign of increased confidence in the economy. Oil futures increased 17 percent since Aug. 27 to settle at $87.70 yesterday on the New York Mercantile Exchange.
“What the Fed is trying to do is reflate the economy,” said Ward McCarthy, chief financial economist at Jefferies & Co. in New York. “To the extent it has prevented expectations of outright deflation and encouraged an increase in the stock market, then it’s been a success.”
To contact the reporter on this story: Caroline Salas in New York at csalas1@bloomberg.net
To contact the editor responsible for this story: Christopher Wellisz at cwellisz@bloomberg.net
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