Bernanke: All Policy Tools Still on the Table

The last month or so has been a tumultuous time in the markets. Fears about the European debt crisis intensified, particularly with regard to Spain, which I wrote in detail about on Tuesday. At the same time, we had several disappointing economic reports, including last week’s weak GDP report and unemployment numbers. Numerous forecasters warned of a new recession just ahead.

This combination of concerns weighed heavily on the global stock markets, while also sending key interest rates to all-time lows as investors fled to “risk-off” positions in Treasuries and cash.  The Dow Jones plunged from above 13,200 at the beginning of May to below 12,100 in just over a month.

Not surprisingly, all this resulted in renewed calls for the Fed to implement additional monetary stimulus, either by extending “Operation Twist” (swapping short-term Treasuries for longer-dated ones), or better yet, QE3. By mid-week, many analysts concluded that the Fed would indeed do one or the other. Many were all but assured that Fed Chairman Bernanke would acquiesce in his testimony yesterday in Congress.

I was not so convinced, especially after reading yesterday’s Fed “Beige Book” report. The Beige Book is a report published eight times a year by the Fed and is a summary of business surveys taken by the 12 regional Federal Reserve Banks. Yesterday’s Beige Book was decidedly upbeat about the economy and even jobs. This came as quite a surprise in light of the latest economic reports and market action.

I think I can explain why yesterday’s Beige Book was upbeat. The 12 Reserve Banks form their assessment of conditions in their region by going out and talking with business leaders in their respective areas. As I reported on May 29, the CEO Confidence Index jumped sharply in the 1Q of this year, from a weak reading of only 49 in the 4Q to 63 in the 1Q. 59% of business leaders predicted an improvement in the economy in the next six months versus only 32% in the 4Q.

The Fed Reserve Banks were surveying business leaders in April and early May when optimism was higher than in the last few weeks. I believe this explains why the latest Beige Book survey was more upbeat. If that same survey was taken today, I believe the results would be much more cautionary.

Now let’s turn to Chairman Bernanke’s testimony and comments from yesterday morning’s meeting with a joint session of Congress. Everyone wanted to know if the Fed is prepared to extend Operation Twist, or better yet, implement QE3. As usual, Bernanke didn’t answer the question. Bernanke did say that extending the Twist or QE3 are both still on the table (as I have maintained for some time), but he added that the Fed is not prepared to do either just yet.

Interestingly, Bernanke warned lawmakers that if there is to be QE3, he doesn’t think it will have a significant effect on the economy. DUH! I would argue that the same was true of QE1 and QE2!

Stocks rallied very strongly Wednesday in part due to the idea that the Fed might do something more in the way of stimulus, even though Bernanke didn’t acquiesce in his testimony or comments in Congress yesterday. The markets know that the next FOMC meeting is on Tuesday and Wednesday, June 19-20, and are hoping for more stimulus from the Fed following that meeting.

I would caution, however, that if Bernanke continues to downplay more stimulus in his press conference on Wednesday, June 20 after the FOMC meeting, the stock markets are likely to be very disappointed. That could spark another sharp selloff.

If there is another market selloff between now and then, I would view that as an opportunity to get back in the market or add to long positions ahead of the Supreme Court decision on ObamaCare on June 25. If the Supreme Court strikes down ObamaCare, I expect a significant rally in stocks afterward – for a variety of reasons.

I sent a SPECIAL ALERT e-mail to all of my clients on Wednesday explaining why I think this could happen. If you want to read my Special Alert, CLICK HERE.

Obviously, the next couple of weeks will be a critical time for the markets, what with the FOMC meeting on Tuesday and Wednesday (Jun 19-20) and the Bernanke press conference to follow. Then the Supreme Court is scheduled to rule on ObamaCare on the next Monday, June 25. Buckle your seatbelts!

Have a great weekend everyone!

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