Federal Reserve Chairman Ben S. Bernanke may be hesitating to extol the improving economy -- in part to preserve the central bank’s own reputation.
While Fed policy makers upgraded their assessment of the outlook at their March 13 meeting after the most-robust six-month period of job growth since 2006, they reiterated their plan to keep interest rates near zero until at least late 2014, citing still “elevated” unemployment and “significant downside risks.” Bernanke said today that continued accommodative policy will be needed to make further progress.
Bernanke’s caution is “appropriate,” said Peter Hooper, chief economist at Deutsche Bank Securities Inc. The Fed chairman risks damaging his credibility by being too optimistic so soon after adopting the 2014 pledge in January and before having conviction about the economy’s momentum, Hooper said. Policy makers fueled speculation in 2011 that monetary tightening was coming by laying out their exit strategy, and they don’t want to guide the market prematurely again, he added.
“They were not at all discouraging some talk about the exit” a year ago, Hooper said in an interview from his New York office. “They’re not going to make that mistake twice. Bernanke is going to be very patient.”
Yields on benchmark 10-year Treasury notes were 2.26 percent at 10:28 a.m. in New York, up from 1.8 percent Jan. 31, according to Bloomberg Bond Trader prices, as manufacturing data improved and jobless claims dropped. The yield had climbed to 3.74 percent in February 2011 as policy makers outlined how they planned to withdraw their record stimulus.
Even though the recent increase reflects signs of strength in the economy, Fed officials probably won’t welcome the rising yields after the unprecedented steps they’ve taken to reduce rates, according to Ward McCarthy, chief financial economist at Jefferies & Co. in New York.
“They don’t like it,” he said. “They have expanded their balance sheet quite substantially to keep rates low.”
In addition to pushing out expectations for higher borrowing costs, U.S. central bankers have kept their benchmark rate between zero and 0.25 percent since December 2008 and bought $2.3 trillion of bonds in two rounds of asset purchases. They’re also pursuing a maturity-extension program announced in September to replace $400 billion of short-term debt in the Fed’s portfolio with longer-term securities. The so-called Operation Twist is scheduled to be completed in June.
Rising bond yields are “a reflection of a stronger economy,” James Bullard, president of the Federal Reserve Bank of St. Louis, said in a Bloomberg Television interview last week. “Low yields might sound good, but” they can “represent a lot of pessimism.”
Bullard, who doesn’t vote on the policy-setting Federal Open Market Committee this year, said U.S. monetary policy “may be at a turning point,” and the Fed’s first interest-rate increase since the global financial crisis may come as soon as late 2013.
Federal Reserve Bank of New York President William C. Dudley offered a more cautious view on March 19, saying signs the economy is improving don’t dispel risks to growth that include higher gasoline prices, fiscal cutbacks and a weak housing market.
The data have been “a bit more upbeat of late,” Dudley said in Melville, New York. “But while these developments are certainly encouraging, it is far too soon to conclude that we are out of the woods in terms of generating a strong, sustainable recovery.”
Declining Labor Participation
About half the drop in unemployment since September “was due to a declining labor-force participation rate,” said Dudley, who is also vice chairman of the FOMC. Had participation not decreased “from around 66 percent in mid-2008 to under 64 percent in February, the unemployment rate would still be over 10 percent.”
Joblessness has fallen to 8.3 percent, the lowest in three years, from 9.4 percent at the end of 2010 and a high of 10 percent in October 2009.
“A wide range of indicators suggests that the job market has been improving, which is a welcome development indeed,” Bernanke said today to the National Association for Business Economics in Arlington, Virginia. “Still, conditions remain far from normal, as shown, for example, by the high level of long-term unemployment and the fact that jobs and hours worked remain well below pre-crisis peaks, even without adjusting for growth in the labor force.”
Communications as Easing Tool
By being more optimistic, Fed policy makers would encourage traders to move up their expectations for monetary tightening. That may weaken the effectiveness of using policy forecasts, like the 2014 plan, as stimulus. Bernanke has said that communications are among the main easing tools left after reducing the federal funds rate.
Bernanke’s view is “‘we’ve gone pretty far here with our verbal policy messages; we’re not about to upset this just because we have a little bit of good data,” Hooper said. “It’s going to take quite a few months of very good news, with the market moving well ahead of them,” before Bernanke will signal the exit is approaching.
Money-market-derivatives traders predict the Fed will lift its target rate for overnight loans between banks a year earlier than the late 2014 forecast. Forward markets for overnight index swaps, whose rates show what traders expect the federal-funds effective rate will average over the life of the contract, signal a quarter-percentage point advance around the October-November 2013 period, according to data compiled by Bloomberg as of March 23.
“Our ability to say with any precision what the date of liftoff will be is very limited,” Bullard said in the Bloomberg television interview. “Markets have to understand that. Policy makers have to understand that as well.”
Dudley stopped short of calling for additional stimulus from the Fed last week, saying “nothing has been decided” about more bond-buying.
“The market focuses on direction and growth rates” of the economy, while “the Fed focuses on levels,” such as unemployment, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. “Year in and year out, that’s one of the most fundamental sources of miscommunication. The Fed cares about the gap.”
Continuing Housing Weakness
Dudley’s focus on weakness in the housing market was supported by data last week showing purchases of new homes unexpectedly fell in February for a second month. Sales dropped 1.6 percent to a 313,000 annual pace, the slowest since October, from a 318,000 rate in January that was weaker than previously reported, according to figures from the Commerce Department. The median estimate of 78 economists surveyed by Bloomberg News called for a 325,000 pace.
Bernanke shared Dudley’s concerns about the impact on consumers from higher energy prices when he spoke before the House Committee on Oversight and Government Reform March 21. Gasoline jumped to a 10-month high last week, with the price for April delivery at $3.3852 a gallon on the New York Mercantile Exchange March 23. Futures have climbed 26 percent this year.
“Higher energy prices would probably slow growth, at least in the short run,” Bernanke said. Rising fuel costs create “short-term inflation pressures, and moreover, they act as a tax on household purchasing power and reduce consumption spending, and that also is a drag on the economy.”
The Fed’s forecasts for growth still are above the average Wall Street prediction. Central bankers predicted in January that the U.S. economy would expand by 2.2 percent to 2.7 percent in 2012, compared with a median projection of 2.2 percent in a Bloomberg News survey of 70 economists from March 9 to March 13. The Fed will update its economic forecasts at its April meeting. The U.S. expanded 1.7 percent in 2011.
Expectations for additional stimulus have declined since the FOMC’s March meeting, when policy makers acknowledged the economy is improving. Forty-seven percent of investors in a Bank of America Corp. survey released March 20 predict no further asset purchases by the Fed, up from 36 percent in February.
While the odds of a third round of bond buying, or so-called quantitative easing, are declining, the Fed’s “pretty dim view of the economy” has kept the option alive, said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut.
“I don’t think they’ll do QE3, but I would readily acknowledge that it’s not entirely off the table,” said Stanley, who predicts the Fed will raise interest rates in mid-2013. “They view the risk of careening into deflation as so much more severe than overstaying their welcome, so they’re prepared to err in that direction.”