Bernanke May Alter Rhetoric, Not Rates After Market Turmoil
By Rich Miller
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Federal Reserve Chairman Ben S. Bernanke
Aug. 6 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke may respond to the latest squall in financial markets the same way he did when turbulence hit four months ago: with a change in words rather than policy.
Bernanke and his colleagues may suggest after their meeting tomorrow that the risks to economic growth have increased following the rout in stock and credit markets -- just as they did after their March meeting.
When it comes to their focus on inflation and the outlook for interest rates, their message will likely be steady as she goes.
``This episode of turmoil is not enough to alter Fed policy,'' says Laurence Meyer, a former Fed governor who's now vice chairman of St. Louis-based Macroeconomic Advisers LLC. He sees the Fed holding its target for the federal funds rate at 5- 1/4 percent through the end of 2008.
By changing what it says, and not what it does, the Fed can show it isn't oblivious to the 7 percent plunge in stock indexes since July 19 and the possible impact that could have on the economy. At the same time, the Fed can avoid being seen as losing its anti-inflationary zeal or as standing ready to bail out investors.
The risk is that such an approach may undercut financial markets still struggling to recover. It might also hinder the economy's recovery to growth of 3 percent or so, from a sub-par 2 percent pace in the first half.
Sales Slump
Housing continues to slump, while consumer spending, until now the bulwark of the economy, is slowing. Auto sales in July were at their lowest level for the month in nine years. Payroll growth slowed in July, and the unemployment rate increased.
``The chances of a recession have now risen to 45 percent,'' says Lyle Gramley, a former Fed governor who's currently a senior economic adviser at the Stanford Group Co. in Washington.
Fed officials play down the dangers to the economy from the decline in stocks during the last two weeks and the tightening of borrowing conditions in the credit markets.
The ``fundamentals are really unchanged,'' Fed Governor Randall Kroszner said in testimony before the Senate Banking Committee on Aug. 2.
While tighter corporate credit may slow growth a bit, company balance sheets on the whole are in good shape, thanks to surging profits, Fed officials say.
Rising Profits
For the 414 companies of the Standard & Poor's 500 index that have reported second-quarter results, per-share profits from continuing operations are up 11.1 percent from a year earlier, according to Bloomberg calculations.
Fed officials are also reluctant to be cast in the role of coming to the rescue with easier credit every time turmoil strikes. That expectation under former Chairman Alan Greenspan was called the Greenspan put, and there's no desire at the central bank for Bernanke, 53, to be seen that way.
``They really want to stay away from the Bernanke put,'' says Louis Crandall, chief economist at Jersey City, New Jersey- based Wrightson ICAP LLC, a unit of ICAP Plc, the world's largest broker for banks and other financial institutions.
Besides, the market's recent contretemps is nothing compared with the 23 percent one-day plunge in the Dow that Greenspan confronted in 1987, his rookie year as chairman, or the shutdown of Wall Street following the Sept. 11, 2001, terrorist attacks.
`Typical Market Upset'
The recent slump in stocks was a ``typical market upset,'' St. Louis Fed President William Poole said July 31 in a speech in Columbia, Missouri.
With the Fed showing no sign of even thinking about changing interest rates tomorrow, investors are focused more on how Bernanke and his colleagues describe the economy as a possible precursor to where policy is headed.
According to futures trading, investors have already increased their bets that the Fed will cut rates by the end of the year. As recently as the fourth week in July, the implied odds were lower than 50 percent.
Some economists expect the Fed to use tomorrow's statement to acknowledge that risks to growth may have grown somewhat while stressing that inflation remains its top concern.
Such a move would be a ``half step'' toward a more balanced assessment of risks, says Tom Gallagher, a senior managing director at International Strategy & Investment Group in Washington.
Policy Makers
That's the approach Bernanke and his fellow policy makers took back on March 21.
Faced with a drop of almost 5 percent in the Dow the month before, the Fed acknowledged the economy had turned ``mixed'' and said future changes in interest rates would depend on the outlook for both inflation and growth. Yet it maintained its forecast of moderate growth for the economy and repeated its mantra that inflation was enemy number one.
Inflation is lower now than it was then. The Fed's favorite inflation measure -- the core personal-consumption-expenditure price index, which excludes food and energy costs -- was running at a rate of 1.9 percent in June from a year earlier. That's within the range of 1 percent to 2 percent that some Fed officials have said they're comfortable with and is down from 2.5 percent in February.
Yet Fed officials aren't convinced that the gains made in lowering inflation can be maintained -- a point Bernanke made in testimony to Congress July 18 and 19.
Tight Labor Market
Feeding their concern: a tight labor market, with the unemployment rate hovering near a six-year low, slowing productivity growth and higher food and energy prices.
Oil prices jumped to $78.77 per barrel last week, before slipping back. Grocery-store food prices increased at an 8 percent annual clip in the first half, the biggest rise since 1980.
``While still focusing on core inflation, the Fed is paying a little more lip service to overall inflation trends,'' says John Ryding, chief U.S. economist at Bear Stearns Cos. in New York. ``There is concern at the Fed that inflation expectations could creep higher.''
The focus on inflation is reminiscent of the approach taken by the Bank of England and other central banks with inflation targets. Bernanke is a long-time advocate of such targets and opposes diluting that approach by trying to influence asset values such as stock prices.
``We've had other moments in the last 1-1/2 years when financial markets dropped,'' says Neal Soss, chief economist at Credit Suisse Group in New York, who worked as an aide to former Fed Chairman Paul Volcker. These ``didn't change the economic outlook and didn't change the Fed's message.''
Neither will this latest one, Soss adds.
To contact the reporter on this story: Rich Miller in Washington at rmiller28@bloomberg.net
Last Updated: August 5, 2007 19:00 EDT
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