While the ISM manufacturing report is on the board for Tuesday, the big event for this week is the August employment report. Of course, it is a matter of debate as to what extent the data is important for the next Fed meeting. Many are taking Federal Reserve Chairman Ben Bernanke's description of labor markets as "grave" as a indication that more action is imminent. Atlanta Federal Reserve Chairman Dennis Lockhart, a generally middle-of-the-road policymaker, seems to believe the data are still important. Via the Wall Street Journal:
"It's a close call" when it comes answering the question of whether the Fed should provide more aid to the economy, Federal Reserve Bank of Atlanta President Dennis Lockhart said. He spoke on the sidelines of the Kansas City Fed's annual research conference here.
Mr. Lockhart said that as he tries to determine what, if any, further stimulus should come from the Fed, he was weighing action against the broader trend of economic activity.
"I'm increasingly of the view that we are on a track that you would, to simplify it, would say is about a 2% growth track with fluctuating job growth. But overall, not a strong enough pace to bring down unemployment to anything close to a notion of full employment in a reasonable time," Mr. Lockhart said.
The policy maker said the fundamental question is whether new Fed stimulus could alter this path. "That's a very tough question. I am not highly confident in the ability of simply monetary action to jump-shift the economy onto a different track," Mr. Lockhart said.
This is the key question - can monetary policy jump the economy to another path? More likely than not, this is the question that has prevented additional action to date. Indeed, it is really the only question that makes any sense given the persistent failure of monetary policymakers to meet either the employment or inflation parts of their dual mandate. Interestingly, Lockhart played down Bernanke's speech:
When it comes to additional stimulus, Mr. Bernanke argued "it could help. I think, one, meaning the press or pundits, or observers, can overinterpret the speech as being, as indicating, his preference for further action," Mr. Lockhart said. "I don't think [Mr. Bernanke] signaled or indicated a particular direction.
It seems Lockhart agrees with my hesitation in embracing Bernanke's speech as a clear indication of the Fed's next policy move. What is promising, in my opinion, is the recognition that if the Fed is going to act, they need to act in a way that will shift the existing paradigm:
If the Fed were to act, Mr. Lockhart said half-measures would not get the job done. While he didn't state what the steps could be, he said stimulus, if chosen, should be "a package. When I say package that means two or three things done at the same time to create maximum possible gains."
Not only does this speak to open-ended quantitative easing, but also communication tools, such as extending the period of expected low rates and quantitative targets for policy.
Also in the news was St. Louis Federal Reserve James Bullard. He would like to wait for more data, but sees which way the wind is blowing:
Mr. Bullard said “it’s clear we have an easing bias,” but he also noted recent data have improved. He said he’d also like to see how the August employment report–due next Friday–turns out before deciding what’s appropriate for the Fed.
Mr. Bullard said he’s willing to be patient and collect more data before acting. But he also said given the current consensus on the committee, “I’d be open to some action”–as long as it was a “relatively smaller move.” He explained the trajectory of recent data doesn’t “justify the large policy moves” associated with bond-buying programs that expanded the central bank’s balance sheet.
The comments on the size of any additional move are interesting in context of his next quote:
If the Fed were to adopt at some point a new asset-buying program, he said he’d prefer that it be open-ended and adjusted on a meeting-by-meeting basis, as opposed to adopting a preset size and end date for the purchases. A flexible bond-buying effort would be “the natural way” to go, and “maybe this way will be the charm if we decided to go that way,” Mr. Bullard said.
I am not sure if market participants have fully come to terms with the concept of open-end quantitative easing. There may be some disappointment if market participants expect a new program will come with a big number, which is my interpretation of Bullard's comment on "large policy moves." Most likely, it will be a small number - something like a commitment to expand the balance sheet by $10 billion a week until conditions justify tightening. A stronger version would be to tie the steady expansion to specific macroeconomic objectives. An even stronger version would be to commit to the program even in the event of inflation in excess of the current 2% target. But my point here is that we should be prepared for an open-ended program to come attached with a number that may be small compared with QE1 and QE2.
FYI - in contrast to Bullard, I think an open-ended program would be a large policy move, even if the numbers appeared small.
Bullard also claims to be more sympathetic to charging interest on reserves, a negative interest rate. I don't know that this idea has much other traction at this point.
Bottom Line: If we believe Lockhart, Bernanke's speech was less of a signal than the general consensus would believe. But if we believe Bullard, the FOMC is moving in the direction of additional easing in any event. Greater than 50% odds, but still a close call? Sounds about right. The employment report could ramp the odds up to 80%, or push us back to the break even point. If they do move, I am expecting an open-ended quantitative easing coupled with a communication tools. Note that an open-ended program is not likely to include a big number. The point of the open-ended program, however, is that it can get big, very big, if needed.
