Federal Reserve chairman Ben Bernanke looks happy here. But will investors be smiling after his eagerly anticipated speech on Friday?
NEW YORK (CNNMoney) — There is probably a greater chance that an earthquake will hit Jackson Hole, Wyo., on Friday at 10 a.m. ET than there is of Federal Reserve chairman Ben Bernanke announcing a third round of quantitative easing.
But you wouldn’t know that from the way the market has been behaving this week.
Stocks were flat Wednesday. However, that followed a huge rally Tuesday and modest gains on Monday.
The market may be bouncing back simply because investors feel the violent sell-off that began in late July was an overreaction. Yes, the economy in the United States and Europe still stinks. But it may not be another depression. Investors have realized that. The market has corrected and it’s time to move on.
Still, a lot of this week’s market “strength” has largely been attributed to investor hopes that Bernanke will offer up more help for the stagnant economy.
It’s as if investors think he’s Mighty Mouse. Or, at a bare minimum, Andy Kaufman lip-syncing to Mighty Mouse. “Here I come to save the day!”
“Investors are going to piece Bernanke’s comments together like a trail of bread crumbs,” said Lance Roberts, CEO of Streettalk Advisors, an investment management firm in Houston. “The market is praying for him to say something positive.”
So can Bernanke live up to the hype? You could argue that investors may now be expecting nothing less than Bernanke parachute jumping out of a helicopter with a case of freshly minted $100 dollar bills onto the stage in Jackson Hole to announce QE3.
But that’s clearly not going to happen. Nor should it.
“If the market is rallying on expectations of QE3, then shame on the market,” said Liz Ann Sonders, chief investment strategist with Charles Schwab Co in New York. “The problem in the economy is not that long rates are too high.”
Exactly. Even after Standard Poor’s downgraded U.S. debt earlier this month, the yield on the 10-year Treasury has continued to decline as investors kept flocking to bonds as stocks tumbled.
Stocks may recover. But don’t expect much.
So what could Bernanke say that won’t freak out jittery stock traders and investors? Experts are hopeful that he merely reiterates what the Fed said earlier this month following its last policy meeting.
At that meeting, the Fed controversially pledged to keep short-term rates “exceptionally low” until mid-2013. Some market experts (not to mention 3 Fed members) disagreed with the notion of spelling out a specific time frame for raising rates.
But the Fed also said that it “will regularly review the size and composition of its securities holdings and is prepared to adjust those holdings as appropriate.” It added that there is a “range of policy tools available to promote a stronger economic recovery” and that it “is prepared to employ these tools as appropriate.”
And it’s that language that market strategists said they are hoping to hear again from Bernanke. In particular, they would love for Bernanke to give more details about those tools — even if one of them is not QE3.
“It’s clear that the market wants to hear about more stimulus. It’s a Pavlovian response. Investors salivate for it,” said Quincy Krosby, a market strategist with Prudential Financial in Newark, N.J. “If Bernanke is not more specific about some of the tools the Fed could use, that could disappoint the market.”
If Bernanke doesn’t give hints about QE3, he could signal that the Fed is willing to take other actions. Economists surveyed by CNNMoney said that lowering the rates that the Fed pays banks on excess reserves could encourage financial firms to lend more.
There also has been chatter in the bond market about how Bernanke could bring back a modified version of the 1960s “Operation Twist” program. The Fed could sell short-term debt and buy longer-term bonds in order to further flatten the yield curve (even though there is some concern it’s already too flat) without adding to its already overstuffed balance sheet.
Discussing those options could be enough to keep investors from pressing the panic button — if not necessarily making them happy.
“Bernanke will let the market know that there is more that the Fed can do,” said Brian Levitt, economist with OppenheimerFunds in New York. “The markets may not be overly enthusiastic, but stocks could sell off if Bernanke doesn’t talk about more arrows in the Fed’s quiver.”
However, even if Bernanke does hint strongly at some sort of stimulus, it could be viewed as a disappointment.
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Many think that more easing won’t actually help the economy. It could lead to more inflation fears if it causes the dollar to weaken and commodity prices to go up. That’s what happened after QE2.
And unless a new round of stimulus is gigantic, it may not that have much of an impact either. That’s because the market keeps expecting more and more.
“QE3 or other stimulus would not help the economy, it would help stocks,” said Roberts. “It’s the liquidity injection that the market has become addicted to, and whether it works is all dependent on how big a program would be.”.
But others argue that supporting stocks, while technically not one of the Fed’s jobs, could help the economy. If nothing else, there could be a strong psychological effect.
“Investors are looking for something to grab on to. Every time stocks go lower, the likely outcome for the economy gets worse,” Levitt said.
Krosby takes it a step further. She said that the Fed, despite criticism, should do everything it can to boost stock prices. A stronger Wall Street could finally lead to more jobs on Main Street.
“Bernanke is the market whisperer. Whether you agree with him or not, it’s clear that investors are going to follow his every word. And he needs the markets to be higher,” she said. “If a higher stock market inspires confidence, that could be a key way to help the Fed indirectly fulfill its jobs mandate.”
The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.