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VOL. 128 | NO. 130 | Thursday, July 4, 2013

David Waddell

Central Bank Bumper Cars

By David Waddell

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Markets last week called Bernanke’s bluff and ended the second quarter on a high note. As we well know, Bernanke spooked markets with a timeline for dousing quantitative easing by mid-year 2014. Bond markets convulsed and the 10-year Treasury yield climbed from 1.61 percent to 2.67 percent. Why would Chairman Bernanke do such a thing?

1) Legacy Preservation President Obama all but announced Ben Bernanke’s retirement. Because Ben fathered quantitative easing, he might want to have influence over its execution. By placing a process and timeline on the table, he has now written a protocol for the next Fed chair. Most likely, the next Fed chair will be Janet Yellen, who favors nominal GDP targeting.

Just to translate, if the Fed adopted a nominal GDP target of 5 percent (i.e., 3 percent GDP growth + 2 percent inflation), then our current numbers (1.8 percent GDP growth + 1.1 percent inflation) fall far short of target. By this measure, the nominal GDP gap could justify even more QE. This would increase the potential inflation fall-out even more, which Bernanke will untimely be blamed for.

By expressing newfound monetary restraint, Bernanke either sets the guardrails for the new Fed chair, or blame-shifts the inflation fallout should the next Fed chair deploy more stimuli. Bernanke knows he will receive a chapter of his own in future finance textbooks. Legacy makes a powerful motive.

2) Invisible Economic Strength Bernanke projects the economy will grow between 2.3 percent and 2.6 percent for 2013. Robust housing activity, falling unemployment, rising stock markets and the sequester wind-down should boost the economy. Unfortunately, as we learned earlier this week, the U.S. economy grew by an anemic 1.8 percent in the first quarter. To hit the mid-point of Ben’s forecast, we must therefore average growth of 2.7 percent for the rest of the year. To be honest, I don’t see it.

3) Spank the Speculators The threat of Fed policy can have equal impact to Fed policy itself. We know that long lasting low interest rates create moral hazards. So by simply flexing, Bernanke cleared out some excesses. Most remarkably, he talked the 10 year interest rate up 63 percent, and yet the stock market fell less than 7 percent, while the VIX volatility index never breached its year-end 2012 level. The speculator spanking in bond markets dwarfed the spanking in the stock markets. How about that for a change!

After Bernanke’s comments, central bankers globally, and many from his own voting committee, accused him of speaking prematurely. Couple that rebuke with weak economic data, and markets seem convinced that Ben’s intentions were to bark, not bite. Whatever the motivation, interest rates are higher (which is good), and the stock market withstood the gut punch (which is also good).

If you had told me a year ago Bernanke would negatively surprise markets and interest rates would spike over 60 percent in short order, I would have predicted a far less benign market outcome. Friday concluded best first six months of the year for the S&P 500 since 1998.

David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.

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