Bernanke's Sept. 11 speech gave no policy hints, but comments from other Fed officials suggest big rate cuts won't come right away
Just how onerous has the current credit crunch been? We at Action Economics have published a report on our Web site reviewing a number of broad credit measures since the unpleasantness began in July. To summarize, there are no signs of widespread ill effects thus far:
1. Yields for broad fixed-income categories have actually declined through the credit crunch period, with hikes only in specific rates that were unusually abrupt, but which still leave rates low on an historic basis;
2. Wider credit spreads—i.e., the interest-rate differential between various categories of debt and U.S. Treasuries—are more than accounted for by lower Treasury yields, and spreads are now arguably in line with historic levels;
3. Declines in commercial paper outstanding are concentrated in the asset-backed category and among paper issued by foreign financial firms, and rapid bank credit growth may be absorbing most of the effects of these declines on the broader U.S. economy;
4. Bank asset growth remains solid;
5. Various consumer and business confidence measures are showing only modest adjustments owing to the credit crunch; and
6. Consumer spending has performed well through August, at least via available sales measures in advance of retail sales.
These observations fit comfortably with the view frequently expressed by Federal Reserve officials that much of the disruptive effect of recent market instability will be temporary, while the effect of any monetary policy adjustments undertaken by the central bank will take longer to play out. This perspective encourages a sober approach to policy, a view echoed in recent comments from Fed officials.
Loath to Ease Policy
Indeed, a review of recent "Fedspeak" shows that most Fed officials have not indicated any strong desire to cut rates, let alone push rates down to the extent the markets are pricing in. It was not surprising, of course, that August comments from Bill Poole, president of the St. Louis Fed; remarks from Jeffrey Lacker of the Richmond (Va.) Fed; and a press interview from Richard Fisher of the Dallas Fed all reinforced the view that the central bank would be loath to ease policy as the markets repriced mortgage instruments—unless there were signs of heightened downside economic risks beyond short-run disruption effects and adjustments in the housing market.
But, this same tone has extended through most Fedspeak thus far in September, with a perspective that is likely shared by Chairman Ben Bernanke. We received no clues on policy from the Fed chief's Sept. 11 speech in Germany, as he stuck to the topic of global financial imbalances. Bernanke was more forthcoming in his late August speech in Jackson Hole, Wyo. (BusinessWeek.com, 8/31/07), as to the Fed's willingness to respond to market and economic disruptions, and at that venue his position was notably balanced with little clear indication that he was committed to a rate cut.
Hawkish vs. Dovish Feedback
Comments made in the wake of the Sept. 7 release of the August employment report by Charles Plosser of the Philadelphia Fed were particularly hawkish, with a focus on the need for policy to be set with regard to longer-term growth prospects and not short-run effects. On Sept. 10, further comments from the Dallas Fed's Fisher highlighted the relatively limited credit crunch pass-through observed thus far, as did comments from the Kansas City (Mo.) Fed's Thomas Hoenig on Sept. 7. Fisher warned that the path of financial turmoil and the policy course has yet to be determined, which further dampened speculation of a rate cut beyond 25 basis points.
On Sept. 10, the Atlanta Fed's Dennis Lockhart sought in his comments to evaluate the August jobs report in the context of recent positive reports on retail sales, hence downplaying the jobs data and leaving a hawkish spin to his talk. Interestingly, only Poole's comments seemed more dovish than in August, though this likely reflected a preference for a less high-profile rhetorical role following political heat for an earlier comment that only a "calamity" would justify a rate cut.
From the dovish side of the aisle, San Francisco Fed President Janet Yellen provided a fairly balanced review of the central bank's circumstance in remarks on Sept. 7. Though we certainly think that this nonvoting Fed president will be happy with a quarter point easing at the next meeting, her presentation repeated the above caveats and did not support an easing decision as aggressively as might have been expected, perhaps via greater focus on downside risks via wealth and credit effects on consumer and business investment.
This more aggressive approach to assessing the policy backdrop was taken, however, by Governor Frederic Mishkin in a Sept. 10 speech. His comments took a notably more dire tone than Yellen's: "economic activity could be affected more severely in other sectors (than housing) should heightened uncertainty lead to a broader pullback in household and business spending. That scenario cannot, in my view, be ruled out, and I believe it poses an important downside risk to economic activity."
The bulk of his comments focused on downside economic risks, combined with inflation concerns that were downgraded as well. His comments suggest that we can certainly identify at least one vote on the Federal Open Market Committee that would be willing to entertain more aggressive action.
Lingering Spirited Debate
In total, the mix of Fed commentary thus far, in the context of the available data on the evolution of the credit crunch, almost uniformly suggests that the Fed is less prone to entertain a more aggressive policy trajectory than some market participants assume.
Still, there is a spirited debate in the markets over what the FOMC will deliver on Sept. 18, with many observers now speculating that the Fed will disappoint hopes for aggressive rate cuts at its Sept. 18 meeting. Yet, some market players continue to argue for bigger steps from the Fed. Implied rates on Fed funds futures point to a 4.49% rate for December and 4.10% for April, 2008. If these rates were to be sustained once the flight to quality premium from credit crunch fears subside, they would be consistent with significant easing from the current Fed funds target rate of 5.25%.
We suspect the Fed is reluctant to lower the target rate currently. Though the surprising 4,000 drop in August nonfarm payrolls certainly gives the FOMC the cover for rate cuts, there have been few signs elsewhere that there's been significant impact on Main Street from the financial debacle on Wall Street. With the Fed's ongoing reserve injections, the effective Fed funds rate is already trading well below the central bank's official target, and most broad measures of interest rates have declined through the period to leave a net reduction in borrowing costs for most businesses. It is not clear that an actual easing in the funds target would necessarily help solve the market's credit woes.
Nevertheless, the FOMC will be pilloried if it doesn't act. We expect a quarter point easing at the Sept. 18 meeting, followed by a similar move in October.