L P L F IN A NCI A L RESE A RCH

Weekly Economic Commentary

#HumphreyHawkins
John Canally, CFA
Economist LPL Financial

Highlights
The Humphrey-Hawkins testimony used to be a rare window of transparency for an otherwise opaque Federal Reserve (Fed), but now it is just one of the many ways the Fed is transparent. In this weeks Humphrey-Hawkins testimony, the market is looking to Federal Reserve (Fed) Chairman Ben Bernanke to apply more of a quantitative threshold on the pace of quantitative easing (QE). We expect the Fed to maintain its accommodative policy.
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On Tuesday, February 26 and Wednesday, February 27, 2013, Federal Reserve (Fed) Chairman Ben Bernanke will deliver his semiannual monetary policy testimony before the Senate Banking Committee (Tuesday) and House Financial Services Committee (Wednesday). For market observers over a certain age, this appearance is, and likely will always be known as the Humphrey-Hawkins testimony. This testimony, which is likely to be followed on social media sites like Twitter under the category #HumphreyHawkins, was mandated by the Full Employment and Balanced Growth Act of 1978, which helped to set into place the Feds current dual mandate of full employment and low ination. The sponsors of the Act were Senator Hubert H. Humphrey of Minnesota and Augustus Hawkins of California hence the original name for semiannual testimony that usually occurs in February and again in July/August and is accompanied by the Feds Semiannual Monetary Report to Congress.

#Transparency
During the 80s and 90s rst under Fed Chairman Paul Volcker (1979 1987) and then Fed Chairman Alan Greenspan (1987 2006) the Humphrey-Hawkins testimony provided a rare window of transparency into an otherwise opaque Fed. In those years, until 1994, the Feds policymaking arm, the Federal Open Market Committee (FOMC), didnt even issue a statement at the conclusion of its policy meeting, leaving market participants, pundits, and the nancial media guessing as to what action the FOMC actually took at a particular meeting. Beginning in 1994, the FOMC released a statement each time they changed policy (at the time, the FOMC was raising rates) but didnt issue a statement if no action was taken. This regime continued until 2000, when the FOMC began issuing a statement after each of the eight FOMC meetings per year. Since then, the Feds transparency to the markets (and to the public) has only increased. Fed Chairman Bernanke now holds a press conference four times a year, and the FOMC publishes forecasts for key policy variables like ination, gross domestic product, and the unemployment rate. From 1993 through 2004, the minutes of each of the eight FOMC meetings used to be published a few days after the next FOMC meeting, roughly seven weeks after the meeting. Since late 2004, the minutes of each FOMC meeting are released three weeks after each meeting. In addition, the FOMC now provides a forecast for the fed funds rate (one of its key policy tools), and

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is currently providing very specic guidance unemployment rates below 6.5% and ination above 2.5% as to when it would begin to raise rates.

Market participants will likely call for even more transparency on Bernakes views on QE.

Despite the dramatic shift toward more transparency at the Fed, many pundits, politicians, and market participants are likely to clamor for even more transparency particularly regarding Bernankes views on the Feds quantitative easing (QE) program. The language in the minutes of the January 29 30 FOMC meeting on Wednesday, February 20, 2013, suggested a shift within the FOMC, and noted that many members of the FOMC are now concerned with the potential risks and costs of further QE, and several FOMC members noted that the FOMC should be prepared to vary the pace of asset purchases. On balance, the minutes suggested that if economic conditions do not deteriorate further due to the scal cliff or some other event the FOMC was prepared to at least scale back the pace of the QE3 (currently at $85 billion per month) later in the year. In this weeks Humphrey-Hawkins testimony, the market is looking to Bernanke for conrmation of the tone of the minutes, and perhaps to apply more of a quantitative threshold on the pace of quantitative easing. We expect Bernanke to comment and be questioned by Congress on the costs and benets of continuing to pursue QE at the current pace.

#Fiscal Policy
On the scal side, Bernanke will likely gently remind his bosses in Congress, and the general public, that it is Congress job to run scal policy. Bernanke almost never misses a chance to chime in on scal policy, even though it is outside of the Feds mandate, as outlined in the Humphrey-Hawkins Act of 1978. Still, Bernanke is likely to be pressed by Congressmen and Senators as to the likely impact of the sequestration on the overall economy, and on various sectors as well. He is also likely to be asked directly about what approach he would favor to address the nations long-term budget problems. Although Bernanke is now starting his eighth and maybe his last year as Chairman of the Fed, he is not yet as adept as his predecessor Alan Greenspan was in dealing with Congress at these Humphrey-Hawkins testimonies. Still, Bernanke has been fairly consistent when asked by Congress (or the public) about scal policy. His remarks at his post-FOMC press conference on December 13, 2012 sum up his view well: ...it will be critical that scal policymakers come together soon to achieve longer-term scal sustainability without adopting policies that could derail the ongoing recovery. Bernanke has also made it clear that the Fed cannot offset the full impact of the scal cliff.

Bernake has consistently called for policymakers to work together on a plan for long-term scal sustainability.

#Tone
As market participants prepare to follow #HumpreyHawkins on social media, investors may wish to focus on the tone of Bernankes comments and his answers to questions. A barrage of hashtags (#economy #employment #Bernanke) may accompany #HumphreyHawkins, but investors will ultimately want to glean how long Bernanke and company will maintain accommodative policy. We expect the Fed will make the point that accommodation is still very much in place.
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LPL Financial Research Weekly Calendar

2013 25 Feb 26 Feb

Dallas Fed Manufacturing Index (Feb) Case-Shiller Home Price Index (Dec) Consumer Confidence (Feb) New Home Sales (Jan) Bernankes Humphrey Hawkins Testimony Durable Goods Orders and Shipments (Jan) Pending Home Sales (Jan) GDP (Q4-revision) Initial Claims (2/24) Chicago Area Purchasing Managers' Index (Feb) Personal Income (Jan) Personal Spending (Jan) Consumer Sentiment (Feb) Inflation Expectations (Feb) ISM (Feb) Vehicle Sales (Feb) Construction Spending (Jan)

Lockhart Bernanke

Italy: Bond Auction Italy: Presidential Election Results

27 Feb 28 Feb

Fisher Evans*

Italy: Bond Auction Germany: Retail Sales (Jan) Eurozone: CPI (Feb) China: HSBC Manufacturing PMI (Feb) China: Manufacturing PMI (Feb) Eurozone: PMI (Feb) China: Non-Manufacturing PMI (Feb) Data due out on Saturday 3/2/13

1 Mar

Hawks: Fed ofcials who favor the low ination side of the Feds dual mandate of low ination and full employment Doves: Fed ofcials who favor the full employment side of the Feds dual mandate * Voting members of the Federal Open Market Committee (FOMC)

IMPORTANT DISCLOSURES The opinions voiced in this material are for general information only and are not intended to provide specic advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your nancial advisor prior to investing. All performance reference is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Gross domestic product (GDP) is the monetary value of all the nished goods and services produced within a country's borders in a specic time period, though GDP is usually calculated on an annual basis. It includes all of private and public consumption, government outlays, investments and exports less imports that occur within a dened territory. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Stock investing involves risk including loss of principal. International investing involves special risks, such as currency uctuation and political instability, and may not be suitable for all investors. The Federal Open Market Committee (FOMC), a committee within the Federal Reserve System, is charged under the United States law with overseeing the nations open market operations (i.e., the Feds buying and selling of United States Treasure securities). Quantitative easing is a government monetary policy occasionally used to increase the money supply by buying government securities or other securities from the market. Quantitative easing increases the money supply by ooding nancial institutions with capital in an effort to promote increased lending and liquidity. Federal Funds Rate is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight. LPL Financial Member FINRA/SIPC Page 3 of 4

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INDEX DESCRIPTIONS The Chicago Purchasing Managers Index is read on a monthly basis to gauge how manufacturing activity is performing. This index is a true snapshot of how manufacturing and corresponding businesses are performing for a given month. A reading of 50 or above is considered a positive reading. Anything below 50 is considered to indicate a decline in activity. Readings of the index have the ability to shift the day's trading session one way or another based on the results. The Dallas Fed Manufacturing Survey is a widely followed monthly survey of state manufacturing and factory conditions. The Eurozone Consumer Price Index (CPI) is the key monthly measure for ination in the Eurozone. The Eurozone Purchasing Managers Index (PMI) measures the opinions of purchasing managers in the manufacturing and services sectors in the Eurozone. Chinas monthly Manufacturing Purchasing Managers Index (PMI) measures the opinions of purchasing managers in the manufacturing and services sectors in China. HSBCs China Manufacturing Purchasing Managers Index (PMI) measures monthly economic trends while attempting to remove seasonal impacts on production and demand, such as national holidays. The index includes data from purchasing executives from both state-owned and private business. Chinas Non-Manufacturing Purchasing Managers Index (PMI) measures monthly economic trends in a range of sectors, from retail trade, to environmental management, to the real estate industry.

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