Financial markets are likely to continue to expect another round of Fed easing for the time being, even if Fed Chairman Ben Bernanke just holds out hope for more without committing to it.
Bernanke gives his much anticipated speech at 10 a.m. ET in Jackson Hole Friday, and because he discussed quantitative easing at the Fed's annual symposium there two years ago, market expectations have been running high that he would promise more.
"I think the market is coming around to the right place in terms of much-reduced expectations of QE," said Alan Ruskin, head of G10 currency strategy at Deutsche Bank. "I don't think he'll close the door on QE, but I think there's a much more realistic perspective that Jackson Hole is not the place to come up with new policy initiatives, particularly when the next meeting is very contentious. There's a sense they'll have an active debate."
JPMorgan chief technical strategist Michael Krauss said stocks could look past Bernanke's speech Friday, if he just repeats previous comments.
"The market will wait, maybe there will be a little bit of disappointment. I think tomorrow is just too early. There are more important things that will happen in the first week of September. The highest probability is that he just repeats previous comments," said Krauss.
"It's hard to understand how much is discounted. With QE1 and QE2, the markets were very weak and he sort of saved them. Now the market has been going up and had a very spirited rally during the summer," said Krauss.
But Krauss said the market is also showing some technical warnings, such as narrowing leadership.
"The market feels like fewer and fewer stocks are driving the market up. If you look at small and mid-caps, they've been underperforming. Dow Transports have been making lower highs," he said. He said if there are two closes below 1390 the S&P would risk a downside acceleration to 1350, or even 1325. His upside target pre-November election is 1435, 1445.
"Clearly the market's fate is in the hand of policy makers and central bankers for the next three weeks," he noted.
Central banks have also kept markets supported, with just the idea more easing could be coming. "There's some warning flags," he said. "The market is bending, not breaking and you do have the carrot (of easing) out there."
Stocks slumped Thursday, after Spain indicated it may delay its request for a bailout, and also as traders talked down the idea that Bernanke would announce new stimulus. The Dow dropped 106 points to the key 13,000 level. The S&P 500 fell 11 to 1399, under 1400 for the first time since Aug. 6. The Nasdaq was off 32 at 3048.
Even though market expectations had been running high that Bernanke would hint at whether the Fed will pull the trigger on a new program of quantitative easing, Fed watchers have said Bernanke will not have enough information on the economy and probably not the agreement of the Federal Open Markets Committee when he speaks in Jackson Hole.
"The speech title on the web site is 'Monetary Policy Since the Crisis,'" said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi. "It sounds like another review of what they've done. When he does hint at things it's always in context of 'yes, we could do X, Y and Z, and of course we'll be talking about this and that when we sit down at the Sept. 12/13 meeting.' The market really wants to see more than that at Jackson Hole. They want to see explicit mention of what they might do."
But Rupkey said it's most likely Bernanke leaves open the possibility for easing or other extraordinary measures, but repeats the caveats that the benefits will have to outweigh the costs, and that further action is dependent on the economy. "The market is going to remain hopeful on this for a while," he said.
Ruskin said the dollar could see slight gains if Bernanke does not lean more toward easing. Quantitative easing has weighed on the dollar while helping lift risk assets, like stocks and commodities. Fed watchers say if there's a new round of QE, it could include Fed purchases of mortgage-backed securities and Treasurys. Some say it could be smaller than previous programs, and run through December, or be open ended. Many economists expect the Fed to extend the end date to keep interest rates low into 2015, from mid 2014.
"The overall message will be we're not out of bullets. We still have the capacity if need be to pursue unorthodox measures, but not going out on a limb and suggest policy easing is inevitable," Ruskin said.
Fed officials have been holding their debate about further policy moves publicly. Early Thursday, Atlanta Fed President Dennis Lockhart told CNBC's Steve Liesman that more quantitative easing, or QE, is a "close call," and Philadelphia Fed President Charles Plosser told him on "Closing Bell" that he doesn't believe QE is what's needed now.
"I don't think it really beats the cost benefits test right now," Plosser said. Plosser said the trouble with the economy is that consumers want to save, and low rates makes that harder. At the same time, businesses don't want to spend because of the uncertainties surrounding fiscal policy, taxes and regulation. Those things, he said, can't be fixed with monetary policy.
Last week, St. Louis Fed President James Bullard said while the Fed's last meeting minutes showed many members favoring easing Aug. 1, the economic news has since improved with a fair amount of data coming in better than economists' forecasts.
There are a few economic reports Friday, including Chicago PMI at 9:45 a.m., consumer sentiment at 9:55 a.m. and factory orders at 10 a.m.
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