To QE or Not to QE?

An analysis of what to expect from Ben Bernanke when he takes the stage in Jackson Hole on Friday

Kathleen Brooks 30 August, 2012 | 12:04AM

This article is part of Morningstar's "Perspectives" series, which is a series of articles written by third-party contributors. Here, Kathleen Brooks from outlines what to expect from Ben Bernanke's speech on Friday.

This Friday 31 August at 3PM (10AM EDT) the chairman of the Federal Reserve Ben Bernanke will make a speech at the Federal Reserve’s annual central bankers’ symposium at Jackson Hole, Wyoming. This speech has been used by Bernanke in previous years to discuss the potential trajectory for US monetary policy, thus his speech is eagerly awaited by the financial markets.

What Could Bernanke Say?

The economic recovery in the US is fragile, the global situation is still concerning – the eurozone crisis is not over and China is still showing signs of slowing down – and crucially for the Fed the labour market has not picked up at the pace  considered necessary to bring the unemployment rate down. In his 2010 speech at Jackson Hole, Bernanke referenced the poor state of the economy and hinted that the Fed would embark on quantitative easing (QE) or asset purchases to stimulate the economy. Be clear: Bernanke will not announce new policy measures during this speech, the most he can do is point to potential future policy options that  the Fed could agree on at the September or November Federal Open Market Committee (FOMC) meetings.

At his 2011 speech Bernanke sounded fairly upbeat on the economy saying that he expected it to strengthen for the rest of 2011. He said there were risks to the economy and that the Fed would be willing to take action if necessary, but in the end the Fed opted for Operation Twist at its September meeting that saw it alter the duration of its balance sheet without extending its size. This move ended up being fairly currency neutral.

The question to ask now is: has the economic situation deteriorated so much this year that Bernanke will announce something with more bite on Friday?

Pre-emptive Action from the Fed

In July the US unemployment rate was 8.3%, back in July 2011 the rate was 9.1%. This is a notable improvement, but it is still high by historical standards and we expect Bernanke to reference this. Included in the minutes of the Fed meeting on 31 July/ 1 August the FOMC noted that the recovery was still vulnerable to adverse shocks and that the unemployment rate would decline only slowly “towards levels that participants judge to be consistent” with the Fed’s mandate. It also saw deflationary pressures rising. A number of members also noted that the fragile state of the economy made it less “able to weather a material adverse shock” without slipping back into recession. So the question now is will the Fed act pre-emptively to try and bolster the economy from the aforementioned “adverse shock”? 

These shocks include the sovereign debt crisis as well as the US’s own fiscal cliff, the Fed sounds worried about both of these events; however it can’t do anything to stop them from happening. Thus the Bernanke may decide to flag up the problems to try and force others to take more action: i.e., the ECB and the US government.

Policy Menu

The minutes from the last Fed meeting gave a very detailed outline of potential policy tools the Fed could use to target growth going forward including:
1. More asset purchases in the form of Treasuries or mortgage-backed securities
2. Extending the commitment to keep rates lower for longer
3. Options to try and boost lending to the wider economy

It didn’t come down in favour of any one method, although it seems unlikely that the Fed will do more QE after repeated attempts have so far failed to bring down the unemployment rate.

Bernanke may not spell out future policy action on Friday because he did so in the minutes, however if he hints that more policy action is on its way then we expect the markets to go into overdrive.

How the Markets May React...

Essentially markets want to hear two things:
1. What policy action the Fed may take
2. When it might be enacted

If Bernanke hints that the Fed would take some action to boost the size of its balance sheet – further asset purchases or lending schemes to try and get banks to lend to the wider economy – then we may see the dollar fall sharply in the immediate aftermath of his speech. USDJPY would most likely be under the most pressure as it moves closely with changes in US monetary policy; we could potentially breach 78.00 and even re-test the early February lows at 76.00. This would also be good news for stocks: the S&P 500 could surge above 1,425 – its recent high – before testing 1,450 towards its highest level since 2007. This would also be good news for the Aussie and other commodity currencies. We could see AUDUSD re-test its recent high at 1.06.

But if he doesn’t hint that more accommodative action is on its way and the Fed isn’t planning on extending the size of its balance sheet then we could see the dollar start to rally. In USDJPY 80.00 may come back into view while the S&P 500 could drift below 1,400 to 1,380 then possibly 1,360. Likewise, commodity currencies may come under downward pressure.

On Balance…

We tend to think that Bernanke will take a middle path and buy some time for the Fed. We don’t think he will dismiss the idea of enacting some form of new policy at future FOMC meetings that extends the size of the Fed’s balance sheet, but we don’t think he will dive in either. He may be non-committal saying the Fed is willing to act without giving specifics. This could lead to a muted risk rally and EURUSD could pop above 1.26 before drifting back to its recent range between 1.2450-1.2570. Likewise, USDJPY might drop initially but we think losses will be capped just below 78.00 around the 77.80 area.

Volatility is likely to pick up, which is welcome after the summer malaise. It could also lead nicely into the other main event – the ECB meeting on 6 September. 

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About Author

Kathleen Brooks

Kathleen Brooks  is research director at, which is a part of GAIN Capital. 

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