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Portfolio > Economy & Markets

No Sign of QE3 From Bernanke as GDP Drops, Markets Rise

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Markets rose Friday after Federal Reserve Chairman Ben Bernanke said he was “optimistic” about the U.S. economy and signaled that the Fed had no plans for a third round of quantitative easing. The markets posted strong gains in early afternoon trading.

The Fed chairman’s speech Friday morning at an economic summit in Jackson Hole, Wyo., came less than an hour after the government reported softening in the U.S. gross domestic product in the second quarter.

“Although important problems certainly exist, the growth fundamentals of the United States do not appear to have been permanently altered by the shocks of the past four years,” said Bernanke in his speech. “It may take some time, but we can reasonably expect to see a return to growth rates and employment levels consistent with those underlying fundamentals.”

Rather than discussing monetary policy, Bernanke instead took a historical look at why the recovery, now in its ninth quarter, has been so modest—and pointed to elected officials’ responsibility for adopting effective tax, trade, and regulatory policies and for fostering the development of a skilled workforce.

“As I have emphasized on previous occasions, without significant policy changes, the finances of the federal government will inevitably spiral out of control, risking severe economic and financial damage,” Bernanke said. “The increasing fiscal burden that will be associated with the aging of the population and the ongoing rise in the costs of health care make prompt and decisive action in this area all the more critical.”

Earlier this month, the Fed announced that it will hold short-term interest rates in a target range of 0% to 0.25% at least through mid-2013, and Bernanke said nothing on Friday to suggest a change in that policy.

Markets dipped immediately after Bernanke’s speech, but began an upward climb afterward. In early afternoon trading, the Dow Jones Industrial Average was approximately 160 points higher, up 1.46%, at 11,320. Nasdaq was up nearly 2.5 percent at 2,479.50. The yield on the 10-year U.S. Treasury bond rose to 2.22%, up from 2.13%, as demand for Treasuries held strong in the face of European instability. Gold was up 25.30, or 1.4%, to trade at $1,781 per ounce, and the VIX index of volatility was down 4.13 points to 35.63.

“It was exactly what the market wanted,” said Keith Springer, president of Sacramento-based Springer Financial Advisors and author of Facing Goliath: How to Triumph in the Dangerous Market Ahead, in an interview with AdvisorOne.

By not suggesting more QE stimulus was needed, Bernanke didn’t give the impression that the Fed is “in panic mode,” Springer added. “By not creating another program, it actually gives the impression that the economy is getting better and nothing else is needed. That’s going to be a positive for the market for the short term. Everyone now feels confident that Bernanke is in control.”

However, gross domestic product data released Friday showed the economy stagnating in the second quarter of 2011.

The Commerce Department’s second GDP estimate for the second quarter showed that the economy grew slower than previously believed, expanding at an annual rate of only 1%, a downward revision from the prior estimate of 1.3%. Economists’ consensus had been for a revised estimate of 1.1%.

On the positive side, though, consumer spending was revised up, with after-tax corporate profits rising at the fastest pace in a year.

Steve Blitz, senior economist with New York-based ITG Investment Research, wrote in a comment released Friday that extrapolating the revised second-quarter GDP report into a double dip recession would be a mistake. Looking to the third quarter, Blitz said that the August equity market has negatively affected expectations and spending habits, but that consumer purchases of cars have given Q3 a boost.

“Indeed, the only negative to current third quarter numbers would have been a rise in imports offset to some extent by a rise in inventories (automobile industry is driving these numbers),” Blitz wrote. “This isn’t to say that the second-quarter GDP numbers are good, or anywhere close to what is necessary to drive unemployment lower. These numbers are, however, a pretty good reflection of what a low growth deleveraging economy, with a shift in emphasis from real estate and finance to the less leveraged world of real goods production and fixed capital investment, looks like.”


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