Thursday, May 18, 2017

Bernanke: Always ‘Puzzled’ By Way Markets Ignore Political Risk Until ‘Last Moment’

Bernanke says Trump should renominate Janet Yellen to serve a second term as Fed chief.


By William Watts
MarketWatch
May 18, 2017

The ability of financial markets to ignore deepening political turmoil in Washington and elsewhere has long puzzled former Federal Reserve Chairman Ben Bernanke.

The Dow Jones Industrial Average DJIA, -1.78% and the S&P 500 index SPX, -1.82%sank and the dollar DXY, +0.22% fell Wednesday as concerns about the fallout from Trump’s firing of Federal Bureau of Investigation Director James Comey and allegations the president leaked classified information to Russian officials finally began to take a toll. But stocks remain not far off all-time highs and had shown an ability to ignore a series of negative headlines over the past few weeks.

That’s not a new phenomenon.

“It always puzzled me a little bit,” Bernanke said In an onstage interview at the three-day, hedge-fund focused SkyBridge Alternatives Conference, or SALT, in Las Vegas. Financial markets have long shown a tendency to be “blasé” about political risks until the “last moment.”

Bernanke said he had previously doubted Trump’s ability to quickly move his policy priorities through Congress, arguing that the Republican sweep of the White House and Congress in the November elections belied divisions within the party.

Those divisions between populist Republicans and more mainstream party members were on display when the first version of a health-care bill collapsed and that those same dynamics will be in play on tax-overhaul efforts and infrastructure spending.

Bernanke recalled that financial markets had also largely ignored the fraught fiscal-cliff battle in the U.S. a few years ago as a looming default deadline approached. Markets also ignored uncertainty tied to Britain’s vote last June to exit from the European Union until it actually occurred.

The market view may reflect a global perspective that recognizes the president is only one part of the U.S. government and has only a moderate impact on growth while the global economy overall is doing better, Bernanke said.

Asked about persistently low market volatility, Bernanke said the phenomenon was “a little puzzling” given that there are “plenty of risks in the world.”

Bernanke said past work by economists Robert Shiller and John Campbell that argued the stock market tended to overreact to the news, showing more volatility than was justified by returns. “One possibility is that markets have wised up to that,” Bernanke said, but added that technical factors, including investor hedging strategies, may also be playing a role.

Bernanke, however, stuck to a relatively upbeat view on the economy, predicting at least a 50/50 chance the current recovery will last long enough to become the longest on record.

He also played down worries the Fed’s plans to begin shrinking its roughly $4.5 trillion balance sheet would inspire a repeat of the “taper tantrum” that sparked a spike in yields and a stock-market pullback in 2013.

Bernanke laid out what he said were key differences between the taper tantrum, which occurred in reaction to his signal that the Fed was preparing to halt asset purchases in the wake of the 2008-’09 financial crisis. The prospect of the Fed ceasing its purchases of Treasurys and mortgage-backed securities at the time also heightened expectations for interest-rate increases by the Fed and monetary tightening by other central banks, he said.

In contrast, the Fed has indicated that it might even temporarily slow the pace of rate increases when it begins to allow the balance sheet to slowly contract, Bernanke said. The Fed has worked to “divorce” the balance sheet issue from rate expectations, which should reassure market participants, he said.


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