Equity markets rebounded as slightly better than expected revised GDP 1.6% from 2.4% when the market was expected a revision down to 1.4%. Additionally, Ben Bernanke comments that the Fed would ensure a recovery in the US markets gave the markets a reason to celebrate. For the day, the S&P 500 Index increased by 17 points to 1066.
Not surprisingly, Bernanke pledged that the Fed would do all that it can to ensure the recovery in the US continues. He also outlined possible steps that the Fed could take, and largely reflect unconventional measures that the market has already been talking about. These step include: additional purchases of longer-term securities, modifying FOMC communication suggesting rates to stay low for even longer than previously anticipated, and reducing interest paid on excess reserves (IOER) to encourage bank lending. He noted that there are pros and cons to all three, but added that if deflation risks were to rise, the cost-benefit tradeoffs could become significantly more favorable for some of the Fed’s tools. Bernanke also said that the recent decision to keep the size of its balance sheet steady “should promote financial conditions supportive of the recovery” and that “additional purchases of longer-term securities would be effective in further easing financial conditions.” However, he acknowledged further balance sheet growth would raise concerns about an exit strategy. With regards to modifying the language in the FOMC’s statement, Bernanke was unsure whether the Fed’s intent could be conveyed with sufficient precision. Regarding a change in the IOER rate, Bernanke noted that rates are already near rock-bottom and so further reduction in IOER rate would have only a small marginal impact.
While Friday’s Q2 GDP revision to 1.6% is going to get the headlines, analysts are quietly marking down Q3 and Q4 expectations. Economist consensus has Q3 and Q4 growth at 2.5% and 2.6% annualized currently. However, the July data has so far come in very disappointing and we foresee H2 markdowns if this trend continues. Business investment in plant and equipment was one of the positive surprises in Q2, and Q3 is likely to show slowing in this category in light of weak durables data for July. Some analyst believe that his 2.0-2.5% Q3 forecast is dependent on robust business investment, and that if data is weak in August, he may have to mark it down to 1.0-1.5%. This sort of trend would tend to support the risk off trading environment, and we note that currency and equity volatility tend to pick up in September and October and so the near-term outlook is dicey for risk assets.