Wednesday afternoon, Federal Reserve Chairman Ben Bernanke stunned the consensus and announced the continuation of quantitative easing. Nearly every major investment bank expected the Fed to taper bond purchases in September, so Bernanke’s surprise announcement ignited a rally in both the stock market and Treasury bonds.
Why not taper? According to the Fed, the economy has not performed up to expectations over the past year, and more importantly, the Fed reduced its growth outlook for 2014. However, in our view, the real reason is that the Fed is concerned about another bout of incompetence from Congress stalling economic progress. The following words came from Bernanke during his post-policy announcement press conference:
“A government shutdown, and perhaps even more so a failure to raise the debt limit, could have very serious consequences for the financial markets and for the economy.”
This wouldn’t be the first time Congressional inaction impacted financial markets: in 2011, when Congress went down to the wire with respect to raising the debt ceiling, credit rating agencies downgraded the US (or turned its outlook negative) while equity markets tanked. Of course, equity markets recovered quite well in the wake of the downgrade, but a shock was certainly sent throughout the financial system. We think Bernanke views expansionary monetary policy as the only possible growth lever since expansionary fiscal policy seems impossible at this point (given competing budget priorities).
Philly Fed Soars
Image Source: Federal Reserve Bank of Philadelphia
Though Bernanke decided against tapering bond purchases, the markets received strong data from the Federal Reserve Bank of Philadelphia Thursday morning. The bank’s Business Outlook survey jumped to 22.3 from 9.3 in August (and came in well above expectations that called for a measure of 10.3). The Business Outlook survey measures the percentage of firms reporting increased activity (36%) less the percentage of firms reporting decreased activity (14%). In short, this number, positive for four consecutive months and reaching its highest level since March of 2011, suggests that economic activity has been strong. But perhaps more importantly, the Philly Fed received very positive forward-looking indicators from reporting manufacturers. From the press release:
“The survey’s future indicators suggest markedly improved optimism among the reporting manufacturers. The future general activity index increased from 38.9 to 58.2, exceeding its previous highs since the end of the recession in 2009.”
Manufacturing firms are still showing potential for continued expansion, and the future outlook has turned even more positive.
Valuentum’s Take
In light of positive data from the Philadelphia Fed, tapering may seem like the right course of action. However, Bernanke continues to show distrust for Congressional competence, and we cannot blame him given recent history. Even if current frontrunner Janet Yellen takes the helm from Bernanke, we suspect she will pursue a similar strategy. In any case, the equity markets continue to perform wonderfully for investors!
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