Ben Bernanke, the FED Chairman in the US gave a speech today that had every economic and market commentator absolutely hanging off of every nuanced word. Listening to the passages would likely put most people to sleep.
And from time to time the phrases that command the most attention change and their focus either diminishes or grows in import. Today the phrase "is prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly,” referring to the Federal Open Market Committee's desire to fight deflation.
So that begs the question: "If Ben Bernanke and the FOMC are stating that they are prepared to fight deflation then is deflation a serious threat?" Now I am not the sharpest tool in the shed but if Ben Bernanke mentions deflation that makes me listen.
Now it was also the revised projected GDP increase of 1.6% annualized in the second half of 2010 as compared to the highest estimate of 1.4% annualized that was also cause for a market rally of considerable strength. My concern is that this weekend all the traders are going to go home and think "Hey...is deflation a real threat? And if it is what room do we have as a nation to fight it?"
Well I believe it is and the US only has a few options left. Basically it amounts to reducing rates paid on reserve balances, securities purchases, or just plain money production. And they are fighting a bit of an uphill battle.
They hold $ 1.1 Trillion in Mortgage Backed Securities (MBS). When rates fall (in order to stimulate the economy) people refinance their mortgages. When this happens MBS get prepaid and money that the FED put out to buy the MBS comes back into their pockets which is monetary tightening. Not the result they were hoping for.
And the US Consumer, that component of GDP that the US is relying on to bring about the hoped for robust recovery is saving instead of spending. The US savings rate is now 6% from its low of just over 1.00% in 2005. That takes money out of the economy and only comes out in new investment or spending. Bored yet?
Simply put the FED has little room to manage, has structural issues that will impede their work, and is doing so hoping that US Consumers will return to their spendthrift ways. How Ben Bernanke does all this without going crazy is impressive. I wish him luck but we are still not equity buyers at this time.