Forbes.com

Agustino Fontevecchia

In his second post-FOMC press conference, Fed Chairman Ben Bernanke touched on every topic, admitting that the recovery was weaker than expected and that beyond temporary factors like supply chain disruptions in Japan and high energy prices, he was at a loss as to what was causing the soft patch.  In a Q&A session with reporters, Bernanke said a disorderly default in Greece would have significant effects on the U.S. economy, while adding that the Fed still had several tools at its disposal to pump up the economy.

If the central bank actually does have more in its tool kit, they will be deployed in a weakening economy. Just before Bernanke spoke the Fed issued its revised forecast, dulling growth estimates for 2011 and now calling for gross domestic product to expand between 2.7% and 2.9%.

Bernanke’s statements rattled the markets, which had remained virtually flat for most of the day.  Equities sold-off as the Chairman began talking, with all three major U.S. equity indices closing at their lows for the day.  The Dow shed 80 points or 0.7% to close at 12,110 in New York, while the S&P 500 fell 8 points or 0.7% to 1,287; the Nasdaq lost 18 points or 0.7% to 2,669.

On the bond front, yields on benchmark 10-year Treasuries hit their lows for the day just before the release of the FOMC state, only to bounce up to a few basis points from 3%, marking a sell-off as prices move opposite yields, and playing into Bill Gross‘ investment thesis. (Read PIMCO’s Bill Gross Shorts Treasuries As Experts Eye Inflation).

With markets at a crossroads, amid a cooling economic recovery and a dangerous Greek crisis threatening the euro and the global economy, reporters grilled Bernanke and asked many of the right questions.

Brutally honest, Bernanke admitted that he had no clue what was actually causing the current fragility in the U.S. economic recovery.  While the FOMC statement assigned blame outside of the U.S., pointing at Japan along with rising food and oil prices, Bernanke was put on the spot by a reporter who noted the inconsistency behind that explanation and a lowering of long term forecasts.  Bernanke took the hit, admitting only some of the factors were temporary and that he didn’t know exactly what was causing the slowdown, but that it would persist.  “Growth,” said Bernanke, “will return into 2012.” (Read No Recovery Possible While U.S. Consumer Continues Deleveraging).

“Bernanke was just summing up what has happened in the markets, what has been priced in,” explained Nick Kalivas of MF Global.  “But the Fed has taken extraordinary measures to support the economy, they have done what they can and monetary policy isn’t a solution for everything,” added Kalivas, pointing at problems with the fiscal situation and the debt ceiling debate.

While Wednesday’s remarks came as little surprise, the blunt discussion of inflation and slowing economic growth offered little inspiration to load up on risk assets like equities.

The Fed chairman was explicit about the situation in Washington, directly slapping Republicans in the face saying “I don’t think sharp immediate cuts in the deficit would bring more jobs.”  Having made clear before that Congress should raise the debt ceiling, Bernanke explained budgetary problems are very long run in nature. (Read Apocalyptic Bernanke: Raise The Debt Ceiling Or Else).

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