Bernanke Grounded -- for Now
The head of the Federal Reserve has so far not lived up to his moniker of "Helicopter Ben." Unlike what his label suggests, Mr. Bernanke has only addressed the current liquidity crisis with system repurchases -- which add temporary cash into the system -- instead of coupon passes, which are a more permanent infusion of cash. By leaving the Fed Funds target rate at 5.25%, he has differentiated himself from Alan Greenspan, whose playbook response to a crisis was to devalue the currency without hesitation.
However, his band aid approach to the credit crunch should prove to be an inadequate cure for what this ailing economy needs. GDP has registered 2% growth in the last 3 quarters, below the 3% trend. Non-farm payroll growth has been averaging 136 thousand new jobs, which is below population growth. And productivity has averaged 1% for all of 2006 and has averaged 1.2% for the first 2 quarters of 2007, below the 2% average for the past few decades.
Although the economy is currently weak, I believe it may begin another leg down in the near future. Whatever growth the economy was experiencing had been bolstered by the recent liquidity boom engendered by record low credit spreads and interest rates. It should be noted that the Fed has not been increasing credit in this latest cycle; it was the banks that fueled the credit bubble. Now that the credit bubble has burst, the already anemic economy might really falter as credit becomes more expensive and harder to come by.
Mortgage equity extractions had reached $800 billion per year at their peak and are now running below $400 billion per annum and falling rapidly, a trend that will only be exacerbated by falling home values and tighter lending standards. The pace of leveraged buyouts should also ease due to higher borrowing costs. And while corporate stock buybacks have exceeded $100 billion in each of the last 6 quarters (a significant portion achieved by issuing debt), corporate borrowing costs have risen 150bps in recent weeks.
It's no great stretch to conclude that we're entering a cyclical deflationary credit crisis as a result of the above. If so, I would suggest investors raise cash and wait for the Fed to commence an aggressive easing policy in an attempt to raise asset price levels. My own view is that they will not lower rates until there is empirical evidence of a recession or a dramatic decrease in non-farm payroll growth and that Mr. Bernanke may want to prove that his "helicopter" moniker is a misnomer, but in the end I believe the Fed will do what it was created to do: inflate.
Related investment themes -- commodities, foreign stocks and a falling U.S. Dollar -- might reverse for a short time but these trends will likely resume their course after brief correction.