Full text of a speech delivered today by Federal Reserve Chairman Ben S. Bernanke in Jackson Hole, Wyoming
Comment of the Day

August 27 2010

Commentary by Eoin Treacy

Full text of a speech delivered today by Federal Reserve Chairman Ben S. Bernanke in Jackson Hole, Wyoming

Many investors have been waiting for this speech in order to get an idea of the Fed's reaction to recent concerns about the integrity of the USA's economic recovery and what the Fed might do to support it should it falter further. Here is an important section
Each of the tools that the FOMC has available to provide further policy accommodation--including longer-term securities asset purchases, changes in communication, and reducing the IOER rate--has benefits and drawbacks, which must be appropriately balanced. Under what conditions would the FOMC make further use of these or related policy tools? At this juncture, the Committee has not agreed on specific criteria or triggers for further action, but I can make two general observations.

First, the FOMC will strongly resist deviations from price stability in the downward direction. Falling into deflation is not a significant risk for the United States at this time, but that is true in part because the public understands that the Federal Reserve will be vigilant and proactive in addressing significant further disinflation. It is worthwhile to note that, if deflation risks were to increase, the benefit-cost tradeoffs of some of our policy tools could become significantly more favorable.

Second, regardless of the risks of deflation, the FOMC will do all that it can to ensure continuation of the economic recovery. Consistent with our mandate, the Federal Reserve is committed to promoting growth in employment and reducing resource slack more generally. Because a further significant weakening in the economic outlook would likely be associated with further disinflation, in the current environment there is little or no potential conflict between the goals of supporting growth and employment and of maintaining price stability.

Eoin Treacy's view Simple ideas tend to have the greatest impact on crowd behaviour and the notion that the US is moving back into recession has been enough to animate investors to pull money out stocks and into bonds. Stocks markets have been largely rangebound for much of the last year, although with trading somewhat lower of late. Government bond markets have been accelerating higher over the last few months. The divergence in the performance of these two measures of investor confidence suggests that the situation is not so simple.

In fact the reality is far more subtle. This chart, from an article by Graham Bowley for the New York Times dated August 21st, indicates that since the beginning of 2009 less than $100 billion has been taken out of US domestic equity funds. Over the same timeframe more than $500billion has been ploughed into bond funds. Since 2008, the supply of bonds has been increasing at a record rate as governments and corporates rush to lock in cheap capital. As a result of the current mood, investors have stopped asking whether this is a sound investment and followed the momentum move.

Today's statement by Ben Bernanke that "the FOMC will do all that it can to ensure continuation of the economic recovery" has given pause to some of those who took another recession as a foregone conclusion and bond prices have pulled back quite sharply, particularly on the longer end of the curve. This downward dynamic marks at least a short-term peak. Additional follow through is now required to indicate a medium-term reversion towards the mean is underway.

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