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The Week: Federal Reserve's Ben Bernanke fires 'his last bullet'

These are stories Report on Business followed this week.

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Fed launches bold plan
Federal Reserve Chairman Ben Bernanke is throwing just about everything he has at America's unemployment crisis, with an aggressive plan to bolster the faltering recovery.

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But there are questions about how much he can do, how fast he can do it, and whether he's running out of ammunition.

"While some form of easing was widely predicted it remains unclear whether these new actions will be any more successful than previous ones given that the problem is not a lack of credit, but a lack of demand, notwithstanding the inflationary risks more QE will have on food and fuel prices," said senior analyst Michael Hewson of CMC Markets in London, referring to the U.S. central bank's QE3, or the third round of quantitative easing.

"There are also the additional risks that given that Europe could well flare up again, Mr. Bernanke has pretty much fired his last bullet, given the open-ended nature of the purchases."

Coupled with the bond-buying plan, Mr. Bernanke and his colleagues on the Federal Open Market Committee, the central bank's policy-setting panel, also pledged to hold their benchmark rate at an emergency low until at least mid-2015, extending the timeline beyond the previous promise of late 2014. That's meant to be a strong message of certainty for some time.

"The FOMC's communication strategy has to-date been effective in reducing long-term interest rates, but it is less clear that it has been as effective in generating a faster pace of economic activity," said senior economist James Marple of Toronto-Dominion Bank.

"One reason for this is that the extended commitment to leave rates at very low levels also acts as a signal that economic growth will be slow for a very long time. This works against the Fed's goal of incenting households and businesses to take advantage of low rates by telling them that the rate of return will be low and highly uncertain. The statement ... makes a clear attempt to deal with this shortcoming by stating explicitly that rates will remain low 'for a considerable time after economic activity strengthens.'"

Fed officials also cut their forecasts for economic growth this year, but boosted the outlook for 2013.

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Mr. Bernanke left the door wide open, and said he will do what it takes to spur growth and bring down unemployment. More than 12 million Americans are out of work and, unlike other central banks, the Fed has a dual mandate to fight both inflation and unemployment.

"I think the Fed will likely continue easing until it's unequivocal that the unemployment rate is on a permanent downward trajectory and is no higher than the mid-to-low 7-per-cent range, accounting for a cyclical correction (up) in the labour force participation rate," said senior economist Michael Gregory of BMO Nesbitt Burns.

"It will likely take sustained payroll job growth well above 200,000 [a month] to accomplish this, and some time to get there - perhaps by 2014 ... The Fed is going to throw the veritable kitchen sink of policy measures at ensuring economic growth becomes both 'substantial' and 'sustainable.' Stay tuned."

The ramifications
Mr. Bernanke's move is not without its ramifications - for other countries.

The Fed plan sparked a rally in markets, pushing up stocks, commodities and some currencies, including the Canadian dollar, which closed just shy of $1.03 U.S. and, according to some observers, is headed for $1.05 as the U.S. currency weakens.

Western Canadian energy producers may have welcomed the jump in the price of oil, but the surge in the loonie only spells more trouble for exporting manufacturers, already suffering because of the strong currency.

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"Canadian manufacturers today have no shortage of headwinds – slowing domestic and foreign demand, the spectre of a European-led financial crisis, and a Canadian dollar which is pushing fresh highs thanks to a third round of asset purchases by the U.S. Federal Reserve," said Toronto-Dominion Bank economist Francis Fong.

The evidence is already there: Statistics Canada reported this week that Canada scored a record trade deficit of $2.3-billion in July as exports sank, and on Friday reported that sales among manufacturers fell by 1.5 per cent, also in July, marking the third dip in five months. Manufacturers in central Canada were particularly hard hit.

Bank of Nova Scotia economist Derek Holt is particularly bleak in his outlook, warning that Canada is "essentially importing" the weakness from the United States through the currency moves, pushed along by the Fed's measures.

"In my opinion, this has CAD over-shooting via a nearly 8-cent rise against the USD since June," Mr. Holt said, referring to the Canadian and U.S. currencies by their symbols.

"At a time when the country is already posting record merchandise trade deficits, CAD's march back in the direction of all-time highs won't sit well with the country's exporters," he said in a report Friday.

"Sure, a rise in commodity prices will help some of them in the resource based sectors and provinces, but I'm not sure this will be as powerful an effect as it has been through efforts to model the past. Indeed, as commodity prices have recovered since the crisis, Canada has gone on to post record trade deficits that reflect U.S. weakness, CAD strength and moribund productivity growth that has soured the country's competitiveness."

Canada is not alone, and the Fed's move could also affect the European Central Bank.

"There is also the fact that a rising euro will do enormous damage to European export competitiveness at a time when the more indebted countries need a weaker currency, not a stronger one," CMC's Mr. Hewson said Friday. "As such, expect the ECB to look at easing monetary conditions further into the end of the year to counter yesterday's actions by the Fed."

Auto makers, union head to wire
The Detroit Three auto makers and the Canadian Auto Workers union are negotiating this weekend against a deadline of midnight Monday.

Much is at stake as the manufacturers try to hold the line on labour costs, and the union seeks to gain ground in an uncertain economic climate.

As The Globe and Mail's Greg Keenan reports, the union said Friday that none of the major issues had been settled.

The union has offered to cut starting wages to less than the current figure of about $24 an hour and stretch the time it takes for new workers to reach full wages of $34 an hour to 10 years from the current six-year period.


Noting that auto manufacturing is "one of the few bright lights" in Canadian industry now, senior economist Mark Hopkins of Moody's Analytics warns of the fallout from a strike.

"Even a one-week walkout could jeopardize Canada's increasingly listless growth, shaving 0.25 percentage point from September GDP while disrupting North American supply chains and retail spending into the fourth quarter," he said.

"Transportation equipment accounted for more than three-quarters of the growth in Canadian manufacturing in the 12 months through June," he added in a report.

"In particular, the resurgence of the Big Three has helped drive a sharp acceleration in Ontario manufacturing, more than offsetting the slowing pace of shipments from Quebec and British Columbia. Improving auto sales in the U.S. have also been a key component of demand growth for Canada's largest trading partner. Stalling this momentum, even temporarily, would be costly."

Market euphoria
There was a lot to get the juices flowing this week, enough to get analysts talking about how the S&P 500 may soon be flirting with record levels again.

Before Mr. Bernanke even fired his big guns, Germany's constitutional court buoyed investors by backing the euro zone's bailout fund and fiscal compact, taking another potential hurdle off the table.

"Mr. Bernanke has lashed himself to the mast of economic stability, throwing the weight of the world's most powerful central bank behind the U.S. economy," said analyst Chris Beauchamp of IG Index.

"Combine that with signs of progress in the euro zone, a rare sight these days, and we now have the potential for markets to push yet higher."

The S&P 500 and the S&P/TSX composite each gained 1.9 per cent this week, the former hitting heights it hasn't seen since late 2007, and the latter still "lagging sorely" this year but regaining momentum, according to Robert Kavcic of BMO Nesbitt Burns.

"Global equities are now in full-scale rally mode, with a handful of major indicies posting double-digit percentage gains on the year," Mr. Kavcic said.

"If recent history is any guide, QE3 might well be the fuel that pushes the S&P 500 back toward record highs - note that is not a wide-eyed statement as it would represent an advance of less than 10 per cent from current levels," he added in a report.

"Fed easing has indeed been the major fuel for the bull market since early 2009, with stocks rallying during QE1, QE2 and Operation Twist, while stagnating in between."

Required reading this week
A disappointing profit outlook from British luxury goods purveyor Burberry Group PLC has heightened concerns that slowing growth in China threatens to spook consumers and pinch booming upscale fashion businesses just as they head into the crucial holiday season, Marina Strauss reports.

Canadian Tire Corp. Ltd. is laying the maple syrup on thick starting next week, as it launches a new campaign that marks both its 90th anniversary and the six-month countdown to the launch of Target stores in Canada, Susan Krashinsky writes.

Two of Canada's largest telecom companies say they will start yanking payphones out of service if the industry regulator does not accept their call for sharply higher rates, Rita Trichur reports.

Canada's $6-billion beef industry is in a state of chronic decline that could soon see the country become a net importer for the first time in at least a generation, a new report says. Barrie McKenna reports.

Gloomy clouds of falling exports aside, Chinese premier Wen Jiabao is confident the country can meet its growth targets this year and called on the world to pull together to find a way out of economic crisis, Carolynne Wheeler writes from Beijing.

What to watch for next week
The Canadian Real Estate Association is expected to report Monday on how the housing market fared in August, and observers expect to see further signs of cooling.

"Monday's report on existing home sales activity is expected to provide much starker evidence that activity is gearing down in a big way," said deputy chief economist Douglas Porter of BMO Nesbitt Burns.

"August was the first full month of the new mortgage insurance rules (notably the 25-year amortization maximum), and by all accounts sales suffered accordingly. Toronto, Edmonton, Ottawa, Victoria and Vancouver have all reported double-digit declines in sales from year-ago levels for August, with the latter posting a nasty 30.7-per-cent slide. Only Calgary has bucked the trend, still managing to post a 16.2-per-cent year-over-year rise."

Bank of Canada Governor Mark Carney has little to fear on the inflation front, although it is believed to have picked up in August.

Economists expect Statistics Canada to report Friday that consumer prices rose about 0.4 per cent in August from July, bringing the annual pace of inflation to 1.3 per cent or 1.4 per cent.

"Inflation has decelerated measurably since the spring, as a slowdown in energy prices held back gains in the headline rate," said Emanuella Enenajor of CIBC World Markets.

"But an uptick in pump prices in August was likely enough to see consumer prices edge up by 0.4 per cent … taking CPI inflation up a tick to 1.4 per cent. Food prices may have also increased, although not as quickly as seen in the prior month."

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More


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