Tuesday, February 26, 2008 7:33:07 AM
Bernanke On The Hot Seat ***
by Dr. Scott Brown
***Welcome New board markers***
February 25 – February 29, 2008
Fed Chairman Bernanke will present his semi-annual monetary policy to the House Financial Services Committee on Wednesday and to the Senate Banking Committee on Thursday. He is likely to hint at further rate cuts, but will also recognize that the Fed must keep its eye on inflation – suggesting that rates are likely to be raised as soon as the outlook improves. Lawmakers will surely criticize the Fed for not doing enough sooner, but it’s hard to say that the Fed hasn’t done a lot already.
There are three major factors behind the current economic slowdown. The first is the housing sector. Residential construction activity will continue to contract, but the drag on overall growth will fade as homebuilding approaches a bottom. The second is the tightening in credit conditions. Despite a 225-bp reduction in the Fed funds target rate (and a 275-bp drop in the discount rate), credit markets remain under considerable strain. The credit troubles have subprime problems at their root, but weakness has spread broadly. Clarification on a bailout of the bond insurers would surely help, and hopefully, Bernanke will share his views on this – but until there is a concrete plan, the credit markets are unlikely to improve much. The third factor is the impact of higher food and energy prices. Household budgets are constrained and discretionary spending has been cut. A softening in the job market threatens to slow aggregate wage income growth. Hence, the near-term consumer spending outlook is poor (and remember, consumer spending accounts for about 70% of GDP).
Many were quick to label the Fed as being “behind the curve.” However, with the exception of the 25-bp cut at the December policy meeting, it’s hard to fault the Fed’s decisions at each point over the last several months. Certainly, with perfect hindsight, the Fed should have eased faster. However, policymakers made up for that in late January, cutting 125 basis points. Remember, the current easing cycle began with a Fed funds rate that was at a high-neutral level, not restrictive. Credit conditions improved in October (the Fed cut by 25 bps at the end of the month), before weakening again in November. In December, credit conditions continued to deteriorate, partly due to seasonal liquidity issues heading into the end of the year. The Fed disappointed the markets at the December 11 policy meeting, but unveiled its new Term Auction Facility a day later. The Fed has been successful in supplying the markets with needed liquidity. However, stimulating the economy has proved to be a different situation.
In a conference call on January 9, it was clear to FOMC members that downside risks to growth had “increased significantly” and most felt that “substantial additional policy easing in the near term might well be necessary.” On another conference call on January 21, officials indicated that data collected since the previous call had “reinforced the view that the outlook for economic activity was weakening.” Strains in some financial markets “intensified” and investors “were becoming increasingly concerned about the economic outlook and the downside risks to activity.” The 75-bp intermeeting cut was made to demonstrate the Fed’s “commitment to act decisively to support economic activity,” and in turn, to reduce the concerns that had weakened financial markets, and to prevent an adverse feedback loop from developing (where tight credit leads to weaker growth and even tighter credit and so on).
At the late-January policy meeting, the five Fed governors and 12 Fed district bank presidents revised lower their outlooks for GDP growth, and increased their outlooks for unemployment and core inflation. The Fed still expects growth to improve in the second half of the year, while moderating food and energy price increases and slower economic growth should keep inflation in check. However, “downside risks to growth remain.”
The Fed sets policy based on where the economy is expected to be six to 12 months away, but also has to balance the risks to the outlook. It’s not an easy job.
http://www.raymondjames.com/monit1.htm
by Dr. Scott Brown
***Welcome New board markers***
February 25 – February 29, 2008
Fed Chairman Bernanke will present his semi-annual monetary policy to the House Financial Services Committee on Wednesday and to the Senate Banking Committee on Thursday. He is likely to hint at further rate cuts, but will also recognize that the Fed must keep its eye on inflation – suggesting that rates are likely to be raised as soon as the outlook improves. Lawmakers will surely criticize the Fed for not doing enough sooner, but it’s hard to say that the Fed hasn’t done a lot already.
There are three major factors behind the current economic slowdown. The first is the housing sector. Residential construction activity will continue to contract, but the drag on overall growth will fade as homebuilding approaches a bottom. The second is the tightening in credit conditions. Despite a 225-bp reduction in the Fed funds target rate (and a 275-bp drop in the discount rate), credit markets remain under considerable strain. The credit troubles have subprime problems at their root, but weakness has spread broadly. Clarification on a bailout of the bond insurers would surely help, and hopefully, Bernanke will share his views on this – but until there is a concrete plan, the credit markets are unlikely to improve much. The third factor is the impact of higher food and energy prices. Household budgets are constrained and discretionary spending has been cut. A softening in the job market threatens to slow aggregate wage income growth. Hence, the near-term consumer spending outlook is poor (and remember, consumer spending accounts for about 70% of GDP).
Many were quick to label the Fed as being “behind the curve.” However, with the exception of the 25-bp cut at the December policy meeting, it’s hard to fault the Fed’s decisions at each point over the last several months. Certainly, with perfect hindsight, the Fed should have eased faster. However, policymakers made up for that in late January, cutting 125 basis points. Remember, the current easing cycle began with a Fed funds rate that was at a high-neutral level, not restrictive. Credit conditions improved in October (the Fed cut by 25 bps at the end of the month), before weakening again in November. In December, credit conditions continued to deteriorate, partly due to seasonal liquidity issues heading into the end of the year. The Fed disappointed the markets at the December 11 policy meeting, but unveiled its new Term Auction Facility a day later. The Fed has been successful in supplying the markets with needed liquidity. However, stimulating the economy has proved to be a different situation.
In a conference call on January 9, it was clear to FOMC members that downside risks to growth had “increased significantly” and most felt that “substantial additional policy easing in the near term might well be necessary.” On another conference call on January 21, officials indicated that data collected since the previous call had “reinforced the view that the outlook for economic activity was weakening.” Strains in some financial markets “intensified” and investors “were becoming increasingly concerned about the economic outlook and the downside risks to activity.” The 75-bp intermeeting cut was made to demonstrate the Fed’s “commitment to act decisively to support economic activity,” and in turn, to reduce the concerns that had weakened financial markets, and to prevent an adverse feedback loop from developing (where tight credit leads to weaker growth and even tighter credit and so on).
At the late-January policy meeting, the five Fed governors and 12 Fed district bank presidents revised lower their outlooks for GDP growth, and increased their outlooks for unemployment and core inflation. The Fed still expects growth to improve in the second half of the year, while moderating food and energy price increases and slower economic growth should keep inflation in check. However, “downside risks to growth remain.”
The Fed sets policy based on where the economy is expected to be six to 12 months away, but also has to balance the risks to the outlook. It’s not an easy job.
http://www.raymondjames.com/monit1.htm
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