Bernanke On The “High Wire”

Tightrope walker performing in a circusAfter talking about it for months, last Wednesday the Federal Reserve Chairman backed off from his decision to begin tapering of the Federal Reserve’s purchases of US Treasury debt.

Could it have been political; we doubt it, since Bernanke has nothing to gain as President Obama has announced his term will end on February 1st of next year.  Bernanke most likely backed off as the result of the sharp increase in the ten-year bond yield, a key interest benchmark for the economy.  Many floating rate mortgages use the ten-year bond yield to index the interest rates on floating rate mortgages.

A slight slowdown in home buying was in evidence in the summer as the ten-year bond yield began to rise after the Fed announced a likely September taper in the spring.  In the new era of Federal Reserve transparency, investors and Fed Governors alike may again yearn for the old days when the Federal Reserve conducted policy behind closed doors.  The bad news is that the stock market has become a “junkie” addicted to monetary stimulus.   Once the tampering finally begins, the US may go through a prolonged period of stock market and interest rate volatility unless the Federal government stops borrowing so much money.

Given the economy’s continued delicate condition, and that the most significant growth engines have been oil & natural gas resource development/infrastructure and residential housing, we believe Bernanke had serious second thoughts that led him to change his mind.  Had he gone through with the taper, mortgage rates likely would have continued to climb.  This would have had a detrimental effect not only on the United States’ anemic GDP growth rates, but would have had a deleterious effect on the tenuous European recovery as well.   Rising US rates would have likely raised borrowing costs or drained precious liquidity from the European Union.

Over the last two days since the announcement of the Fed decision to not begin the taper, the ten-year bond yield has declined by 20 basis points.  In the last several months, there is finally some steady improvement in first time unemployment claims.  Also, after some weak months, industrial production has begun to rise.

Despite these improvements however, the Consumer Confidence Index declined significantly over the last two months.  This decline in confidence was probably due to economic headwinds not only from the rise in interest rates caused by the announcement of the taper, but also from recent increases in gasoline prices, and the ObamaCare kick-off scheduled for October 1.  The advent of ObamaCare will likely adversely impact the US consumer, especially in the next year, when penalties (taxes) and changes to corporate health care coverage begin to take effect.

Throw in some October political high jinks surrounding the debt limit, and we believe US equity markets will experience some volatility in October.   We see no reason to change our existing forecast of low US economic growth throughout fall.

This is the “high wire” circus act facing Bernanke over the remainder of this term, and for the next Federal Reserve Chairman, whoever that may be.

Paul A. Balboni

September 20, 2013

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