Waiting for Bernanke, Draghi - or Godot

Reuters.

US Federal Reserve chairman Ben Bernanke.

“We're saved!” cry Vladimir and Estragon in Samuel Beckett's allegorical play Waiting for Godot, whenever they think Godot may be approaching.

Sound familiar? For Godot, just substitute the Fed and QE3 and there you have markets' joyous reaction to the slightest hint the US Federal Reserve may be about to embark on its third money-printing, quantitative easing (QE) round.

But Godot represents not only Fed QE3 - an attempt to stimulate the economy by pumping money into it - but also the European Central Bank and the People's Bank of China, both of which are expected to act to support growth.

Almost two-thirds of investors believe QE3 is on its way, a Reuters poll finds. Another poll reveals markets are confident the ECB will buy Italian and Spanish bonds from September and will cut interest rates to record lows..

And in China, investors expect the PBOC to loosen banks' required reserve ratio by at least 1 percentage point by the end of 2012, freeing up more cash for lending.

Such is investors' faith in Godot's ultimate appearance that they have driven up world shares 3.5 percent since the end of June, shrugging off fairly lacklustre company earnings as well as dire growth and manufacturing data almost everywhere.

Betting that the ECB will do the right thing, markets have pushed Europe's top stock index 7 percent higher in August and brought Spanish yields 120 bps down from July highs.

Next week they may get an inkling of when, if at all, the Fed might turn on its printing presses.

Fed boss Ben Bernanke speaks on August 31 at a central bankers' get-together at Jackson Hole in Wyoming. Given Bernanke announced a previous QE round at the same shindig a couple of years ago, expectations are high he will do the same this time.

To see whether the ECB fulfils its pledge to “do whatever it takes”, investors must wait until its Sept. 6 meeting.

But market players such as Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets are confident. He sees QE3 from the Fed overshadowing all risks over the next couple of months.

“QE3 for September seems to be in the bag,” Gijsels says.

“We continue to give the market the benefit of the doubt, despite the clear and present dangers like Greece, Spain and the US fiscal cliff,” he added, referring to looming deadline for the expiry of crisis-era US tax breaks.

A host of trades, from short-dollar to long-bonds, emerging markets to oil futures, hang on the bet for central bank action.

It has driven a jump in stock market positioning - a Bank of America/Merrill Lynch poll showed funds had a net 12 percent equity overweight in August, from 3 percent in July. Underweight positions in Europe fell to net 13 percent, halving from July.

Other central banks such as Brazil and Colombia are expected to cut rates next week and there is a chance of a rate cut in Hungary too. But investors' eyes are on the Big Three.

WHAT IF

Now, here's the rub. What if central banks, starting with Bernanke next week, don't deliver what markets want? Volatility levels are near five-year lows, implying that markets are not priced for nasty surprises.

In Europe, not everyone on the ECB board sides with Draghi on buying periphery bonds. And Germany cannot ratify the European Stability Mechanism, the bloc's permanent rescue fund, unless its constitutional court approves it on September 12.

For QE3, the minutes of the last Fed meeting said “fairly soon”. But as James Bullard of the St Louis Fed has noted, data since then has shown signs of an uptick in the US recovery.

“There is always risk of disappointment when everyone believes it's going to be one-way,” said Peter Wilson, who helps run a $6 billion bond portfolio at First International Advisors, a subsidiary of Wells Fargo.

Creeping doubts pushed 10-year Treasury yields to three-month highs for a while, an implicit policy tightening effect, Wilson notes. That leaves the Fed with no option but to print money, he reckons, with question marks only over the timing.

But overstretched bond markets could still be disappointed, for instance if the Fed goes down the route of purchasing other assets such as mortgage securities, Wilson said, adding: “If that happens you would still see Treasuries underperform”.

The US housing market has regained its footing, consumer sentiment is rising and bank deleveraging has progressed, argues Rob Drijkoningen, a fund manager at ING Investment Management. He is among those who expect no fireworks at Jackson Hole.

“I'm in the camp of no QE3 for now so that may lead to some disappointment,” he said. “Bernanke won't be too worried.”

What of China, where the PBOC's silence has driven stocks to 3-year lows and weakened the yuan. Defying investors' hopes, the bank has steered clear of rate or RRR cuts, resorting instead to a temporary arrangement of cash injections to interbank markets.

Possibly the fear of reflating a housing bubble created by its own massive post-2008 stimulus, will making the PBOC wary of drastically easing policy even though data this week showed China's factories contracting sharply.

Back to Beckett. Those familiar with his play will recall Godot doesn't show up. Vladimir and Estragon are instead told to expect him another day, leading them to contemplate suicide. - Reuters