In a speech on the US labour market in Washington this week, Federal Reserve chairman Ben Bernanke raised doubts about the sustainability of recent employment gains that seem to be running ahead of the economic recovery.
He points out: “Conditions remain far from normal, as shown, for example, by the high level of long-term unemployment and the fact that jobs and hours worked remain well below pre-crisis peaks, even without adjusting for growth in the labour force.”
Bernanke wonders if recent improvements might simply denote a reversal of sharp job cuts made in 2008 and 2009, and argues that cyclical factors relating to the economy rather than structural factors – such as a gap between US worker’s skills and employers’ requirements – drive unemployment. Therefore “accommodative policies to support the economic recovery will help address this problem”, he says.
Investors that had worried about an upturn in 10-year US Treasury yields and the potential for rising rates to take hold and cause ugly losses among those long bonds – banks for example – took some comfort.
The S&P 500 closed the next day at its highest level since 2008 and the VIX hit its lowest level since June 2007. As March drew to a close, hopes were rising for another dose of quantitative easing.
“Is it really that simple?” asks Jim Reid, strategist at Deutsche Bank, whose reading is that Bernanke had nudged open the door to QE a touch. “Have we now found the cure for the five-year financial crisis? Can we just have an assumption that if things get worse intervention will again be round the corner?”
It seems there is little doubt among economists that the Fed will at the very least fulfil its vow to keep rates lower for longer and might well look to further extraordinary measures if unemployment should start to rise again later this year.
However, before the bond bulls get too excited, it’s worth recalling that Bernanke will still have an argument to win inside the Fed. There are voices arguing that further increasing liquidity will have little positive effect and could even do some damage.
As president of the Dallas Fed, and a proud supporter of Texas as the one main US region to have restored employment to pre-crisis levels thanks to business-friendly regulation, Richard Fisher is something of a one-man awkward squad. He was against QEII and operation twist, arguing that it wasn’t lack of liquidity holding back business expansion in the US but uncertainty around burdensome regulation.
“Businesses have no idea what their taxes will be next year, what government spending will be, what healthcare costs will be,” he told a lunch gathering in London, organized by the Centre for the Study of Financial Innovation the week before Bernanke’s speech on labour market developments.
He would clearly be against a third round of quantitative easing, with $2 trillion of cash on corporate balance sheets. “It disincentivizes the class who has key decisions to make, meaning the political class. The longer the central bank gives them an excuse not to act, they won’t act.”
He adds: “The nightmare scenario now would be for central banks to discard their responsibility.”
Fisher won’t be supporting anything that smacks of semi-permanent monetizing of the national debt.
He goes so far as to call the US legislature dysfunctional and guilty of fiscal misfeasance, and makes clear his admiration for Mexico’s adoption both of an independent central bank and a balanced budget law. He says the most important recent initiative at the Fed – one for which he says all the credit is Bernanke’s – has been to make it clear it can target an inflation rate.
Fisher says the central bank cannot target an employment rate because that is so subject to non-monetary factors.
With 10-year US Treasury bond yields rising in March, Fisher’s audience wanted to hear his views on how to exit the quantitative easing he opposed and that has swollen the Fed’s balance sheet from $800 billion to $3 trillion.
A former markets man but now an experienced central banker, he doesn’t give much away. “The 10-year treasury could back up for good reasons, because our economy is starting to do better, or bad reasons if people are becoming fearful of inflation,” he says.
He points out that the best time to exit – the conditions that the Fed presumably will wait for – would be against the background of robust economic growth and fiscal probity, and that the tools could involve reverse repo to the banks as well as selling assets.
“But how will you manage this without causing the markets to sell off?” asks one anxious investor. Fisher fixes him with a look straight from Texas: “It is not our job to make financiers rich.”
He has one last delightful phrase to point out the ultimate limit to any widespread sell-off in US Treasuries: their enduring safe-haven status.
“It’s not clear how much benefit we got from operation twist,” he says. “But when investors started to worry about the euro, we saw a flood into US Treasuries. There is a benefit to being the best-looking horse in the glue factory.”
No doubt bond investors will feel comforted.
