Ben Bernanke Stays Hypothetical and Mario Has No Clothes

When U.S. Federal Reserve Chairman Ben Bernanke stepped to the podium at Jackson Hole last Friday he did not announce any revolutionary new monetary policy initiatives, as market speculators were hoping he might. Instead, he reviewed the options that the fed still has at its disposal and made it clear that he is willing to use any and all of them if circumstances warrant.

Mr. Bernanke’s approach was straight out of the modern central banker’s handbook where putting your finger on the trigger of your policy gun and talking about how you might use it often proves more effective than actually firing off a round. (This is especially true for central bankers who wore out their real monetary policy guns and traded them for water pistols long ago.) In today’s reality, it is only the threats of what central bankers might do that are keeping speculators in check (a precarious state that is pretty close to the last line of monetary defense).

This now standard operating procedure also explains why European Central Bank (ECB) President Mario Draghi suddenly announced that due to his “heavy workload”, he could not attend the Jackson Hole conference and deliver his much anticipated speech called “The future of the euro: stability through change”. A heady title indeed.

Mr. Draghi did his best Dirty Harry impersonation last month when he warned speculators that the ECB would do whatever it takes to save the euro – and it worked. Spanish and Italian bond yields dropped and markets calmed to a degree that I found surprising. But shortly thereafter Mr. Draghi failed to follow through with any new monetary policy initiatives at the ECB’s next meeting and even backtracked a little at his post-meeting press conference.

His Jackson Hole speech was put-up time and without the authority (or the mandate) to begin buying Spanish and Italian bonds directly and on a massive scale, Mr. Draghi knows that he cannot keep stepping up to the podium without backing up his tough talk. At some point, the markets are bound to start questioning what’s really in Mr. Draghi’s holster.

(Note about the “I’m too busy” excuse: I wouldn’t argue that Mr. Draghi doesn’t have a lot of extra time for euchre these days but if you were trying to prevent the collapse of the largest monetary union in history, wouldn’t a brainstorm with the world’s most senior central bankers be something you would make time for? You know, unless you were walking around naked and didn’t want people to figure out that you weren’t wearing any clothes? If we’re down to flimsy excuses, wouldn’t the sudden onset of laryngitis have solved the podium problem while still putting you in the room, Mario?)

With Jackson Hole now in the rear-view mirror, a fresh round of speculation begins about what the ECB might announce at its next meeting this Thursday and about whether the U.S. fed will invoke new policy measures when it meets on September 12. Once again, the answer to what the ECB and the U.S. fed might do dangles just beyond our reach, keeping investors hopeful/fearful enough to sit tight for a little longer while the stewards of the global financial system play for a little more time.

Government of Canada (GoC) five-year fixed rates were 6 basis points lower for the week, closing at 1.35% on Friday. There may be some softening in five-year fixed mortgage rates this week as lenders bring their five-year fixed-mortgage rates back down to the 3% range.

Five-year variable-rate discounts are available in the prime minus .35% range (which is 2.65% using today’s prime rate) and as such, I still think borrowers who want to save money at the short end of the yield curve are better served to consider one-year fixed terms, which can be found at rates as low as 2.49%.

The bottom line: Uncertainty about the timing of more U.S. fed stimulus aside, the game of bond-market chicken between euro-zone speculators and the ECB will continue to drive yield volatility over the near term and the ECB will only go only so far the speculators force it to. An eerie calm has kept our bond yields (and our mortgage rates) relatively flat over the late-summer but I think bond investors will seriously test the strength of Mr. Draghi’s monetary weapons if he doesn’t announce something significant soon.

If past is prologue, when that showdown happens, a by-product will be increased investor demand for ultra-safe assets which will push GoC bond yields and our fixed-mortgage rates still lower.