Ben Bernanke, Social Worker

The Western World has become central bank-centric.  While China seems to be furiously ginning up public works projects to support growth, Europe and the U.S. are relying on monetary policy.  Financial markets have taken notice, expecting the money spigots to begin gushing again.

That may be the problem for equity investors.  If new money creation is already baked in the cake, the time-worn axiom of buy the rumor and sell the news could well be in play.  We expect swimming in place to be the trend until decisions from the Federal Open Market Committee and a German constitutional court are announced midweek.

First to the old world.  The European Central Bank authorized unlimited bond purchases last week, making good on ECB chief Mario Draghi’s word to do whatever it took to defend the euro.  But a group of German lawmakers are seeking an injunction preventing German participation in the plan.  The court rules Wednesday.

On this side of the Atlantic, all signs point to what we have been expecting since the summer began – a third round of quantitative easing by the Fed.  It has long been our opinion that the Fed was duty-bound by both statute and conscience to act anew.  With the August jobs report showing a disappointing addition of 96,000 jobs and an unemployment rate pushed down only by an exodus from the work force of the forlorn, it seems the Fed has all the cover it needs to boost money supply growth in the hope it translates into real economic activity.

For his part, Fed Chairman Ben Bernanke made it clear at Jackson Hole the week before that policy makers could and would act if needed, remarking not only on the dry numbers describing the economic landscape but the cost to the social fabric of continued bleak employment prospects.

“As we assess the benefits and costs of alternative policy approaches, though, we must not lose sight of the daunting economic challenges that confront our nation.  The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years,” Bernanke said.

He also laid the groundwork for further action by defending the efficacy of the Fed’s prior rounds of extraordinary bond buying.

“For example, a study using the Board's FRB/US model of the economy found that, as of 2012, the first two rounds of LSAPs[large-scale asset purchases] may have raised the level of output by almost 3 percent and increased private payroll employment by more than 2 million jobs, relative to what otherwise would have occurred,” he said. 

The rubber meets the road Wednesday when the FOMC is slated to announce its policy decision.  At the very least, expect language in the directive extending the time horizon for keeping the Federal Funds rate target close to zero.

As for political considerations, we think they are also zero.  The Republican presidential candidate, Mitt Romney, has already said he would replace Bernanke, a Republican, if elected.  And the lags in monetary policy’s effect on the real economy prevent any palpable help for President Obama before the November election.

Meanwhile, the usual round of economic reports that follow the tone-setting employment data is slated for release.  Inflation news should be of no consequence, despite rising food and oil prices.  The biggest market mover outside central bank actions is likely to be Friday’s release of August retail sales.  Economists expect another 0.8% increase over the prior month.  A shortfall could hit markets hard if the Fed has failed to act.