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March 21, 2006
Bernanke's no Greenspan - look for higher rates
Former Federal Reserve chairman Alan Greenspan was famous, or infamous, for his cryptic remarks and speeches that required a Kremlinologist's skill for parsing, a finance Phd’s knowledge of market history and a gambler’s instincts of where to place a bet. I don't think life is going to be anywhere near as complicated under his successor, Ben Bernanke based on Big Ben's speech last night at the Economic Club of New York.
Analysis of the speech was all over the map, but a simple reading shows Bernanke sees a strong economy in need of more rate hikes. Net net, it's got to be a negative for short-term bonds and for those stock market investors betting on a quick end to the rate hike campaign.
Where do I see that in last night's speech? In his discussion of long-term bond yields and monetary policy, Bernanke raises and then completely dismisses, the one solid piece of evidence that the economy is slowing: the inverted yield curve. Investors’ expectations about future rates include several components, he explained. Investors looking back over the past 20 years of declining inflation and stable growth may be driving down long-term rates because they see less risk in the future. If that’s why rates are low, the effect is to stimulate the economy and thus require more Fed rate hikes.
But, if investors expect the economy itself is slowing and the Fed may have to start cutting rates to stimulate growth, they might also bid down long-term rates. In that case, the case of the typical inverted yield curve, the Fed should stop raising rates, Bernanke said. So where does Big Ben come down? He tells us flat out:
“What is the relevance of this scenario for today? Although macroeconomic forecasting is fraught with hazards, I would not interpret the currently very flat yield curve as indicating a significant economic slowdown to come, for several reasons.”
If that's not enough, Bernanke also footnotes a paper written last month by Fed economist Jonathan Wright that takes a close look at yield curve prediction models and concludes "this flatness accordingly does not seem to herald a sharp slowdown."
Look out below…
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