Bernanke Speaks - Patience, Markets' Reaction - Impatience

Expectations always are a distribution around the consensus. Today Bernanke gave us the consensus and the "ease now" camp was disappointed. Weaker growth and disinflation will prompt Fed action - just not today.

"Pace of growth less vigorous than expected"

Chairman Bernanke highlighted a patient, thoughtful approach to policy - if the economy weakens and we get further disinflation we will ease. Certainly, this is disappointing to those who expected more today, but the approach is consistent with thoughtful policy. The Fed does not appear to be panicked into action at this time.

On the economic front Bernanke cited that "economic recovery and repair remains far from complete." We agree. Moreover, Bernanke stated that "fiscal impetus and the inventory cycle can drive recovery only temporarily." In rush to hype, this bit of classic Economics 101 has been forgotten - if you need a refresher pull Mankiw, Macroeconomics, sixth edition off of your shelf and reread chapter 11. (If it's not on your shelf, a standard Macroeconomics textbook should be). "For a sustained expansion, growth in private final demand, must ultimately take the lead." Politicians running for public office please, take note.

"Labor market data disappointing"

Chairman Bernanke notes that household saving has been higher than the Fed expected and consumers remain cautious. Household balance sheets continue to be repaired. A more cautious consumer reflects Bernanke's assessment that "the labor market...remained disappointing." Today's labor market reflects a mix of structural change and cyclical corrections. No matter what the mix, the consumer credit and spending picture has been altered for some time to come. This suggests slower consumer spending going forward.

Our outlook is for consumer spending growth of 1.5 percent for the second half of this year. Therefore, while continued economic growth is expected, the pace of gains will be disappointing to many who were hopeful for a boom and also disappointing to those betting on a double dip. Meanwhile, slower growth generates an unemployment rate at 9.5 percent or greater for the second half of this year.

"Inflation declined to level slightly below level conducive to healthy economy... Risk of further disinflation seems low"

Inflation is expected to remain low and this opens the door for the Fed to ease if the economic outlook deteriorates. Our view is that inflation remains low and that there is no deflation; however, the risks and costs are on the downside. Lower inflation from here is far more expensive for the economy than a rise of inflation of equal magnitude. Movements in price inflation are asymmetric. Therefore, our view is that the Fed is more likely to engage in further quantitative easing - most likely after the November FOMC meeting. By then the election will be over and we will know third-quarter GDP - we expect another disappointment for the Fed.