Bernanke Dodging Jabs on Rates Holds Back Treasuries
It’s an election year and unemployment is high. Congress’s response? Give the Federal Reserve a break.
Lawmakers who will question Fed Chairman Ben S. Bernanke this week during his semiannual report on monetary policy say in interviews they recognize he has little left in his arsenal after reducing the federal funds rate on overnight loans among banks almost to zero and buying $1.7 trillion of securities to lower mortgage costs.
Instead, Democratic Senator Jack Reed says he wants Bernanke to use his “bully pulpit” to pressure Congress to make up for declines in spending by states and municipalities. Republican Senator Mike Johanns says Bernanke should urge President Barack Obama to “quit hammering businesses” with policies such as tighter financial regulations that may restrict employment. Politicians say they also want the Fed chairman to help reverse a drop in loans to small businesses, which account for more than half of U.S. job creation.
“There aren’t a lot of bullets left in that weapon” of monetary policy, said Johanns, 60, of Nebraska, who served as secretary of agriculture from 2005 to 2007. “I just don’t think there’s one or two things they could do and it would make it right,” said Rhode Island’s Reed, 60, the banking committee’s No. 3 Democrat behind Chairman Christopher Dodd of Connecticut and South Dakota’s Tim Johnson.
A lack of additional monetary stimulus would restrain a rally in long-term government bond prices, said Stuart Thomson, who helps manage the equivalent of about $100 billion at Ignis Asset Management in Glasgow.
“Without the Fed’s help, the flattening of the yield curve will be much slower,” Thomson said. Should the central bank fail to act, yields on two-year Treasuries would drop to 0.4 percent by the end of 2010 from 0.59 percent on July 16, and the 10-year rate would decline to 2.75 percent from 2.92 percent.
With Fed action, which Thomson ultimately expects because of a slowing economy, the 10-year Treasury yield would fall to 2 percent and the two-year yield would decline to 0.5 percent, Thomson said.
The Fed’s aversion to further stimulus now means stock investors should expect slow earnings growth and look for companies with access to faster-growing markets, said Jerry Webman, chief economist and senior investment officer at OppenheimerFunds in New York, which has more than $155 billion under management.
“It isn’t just about selling Gucci handbags in Shanghai, although a big part of it is that,” Webman said, referring to the luxury brand owned by France’s PPR SA. “It does mean identifying markets that have spending power and more rapid growth than the U.S. consumer.”
Bernanke, 56, is scheduled to testify on July 21 at 2 p.m. before the Senate committee, and the next day before the House Financial Services Committee, chaired by Massachusetts Democrat Barney Frank.
While Fed officials have said the central bank has no plans to deploy additional tools to accelerate the recovery, it does have options for monetary stimulus.
These include additional asset purchases, reducing the 0.25 percent rate it pays on bank cash reserves it holds and declaring that the “extended period” of low rates depends on a specific economic indicator or will last a specific length of time, Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, said in a July 8 research note. None would be as effective as a traditional move of cutting the federal funds rate target by 1 or 2 percentage points, said Feroli, a former Fed researcher.
Policy makers trimmed economic-growth forecasts for this year and next during the Federal Open Market Committee’s June 22-23 meeting in Washington and said they would need to consider additional stimulus “if the outlook were to worsen appreciably,” according to the minutes, released July 14.
Central-bank officials projected expansion for 2010 would range between 3 percent and 3.5 percent, compared with their previous estimate of as much as 3.7 percent. Growth in 2011 would be between 3.5 percent and 4.2 percent; the earlier forecast was as much as 4.5 percent.
“We’re being held back by a shortage of capital in the banking system; that’s nothing about monetary policy,” said John Ryding, co-founder and chief economist of RDQ Economics LLC in New York and a former Fed economist. The economy is also “held back by uncertainty over the regulatory and tax outlook for next year. Monetary policy can’t do anything about that.”
Falling Consumer Confidence
Consumer confidence fell this month to the lowest level in a year, according to a Thomson Reuters/University of Michigan preliminary index released July 16. Private employment growth rose 83,000 in June, less than the 110,000 gain forecast by economists in a Bloomberg News survey, and new-home sales plunged an unprecedented 33 percent in May after a tax credit expired.
The situation Bernanke faces contrasts with 1992, when former President George H.W. Bush’s administration clashed with then-Fed Chairman Alan Greenspan about keeping interest rates too high after the 1990-91 recession. The Greenspan-led Fed cut the benchmark rate to 3 percent from 4 percent in 1992. Bush later said Greenspan’s actions helped cost Bush the presidential election that year.
The Fed “has acted in an almost timid manner and has reacted instead of being ahead of the curve,” then-Senator Alfonse D’Amato, a New York Republican and member of the banking committee, told Greenspan during his semiannual testimony in July 1992, when the jobless rate was 7.7 percent, near the highest since 1984.
Almost two decades later, few people accuse Bernanke, who began a second four-year term in February, of being too timid during the past year. He and his colleagues lowered the overnight interbank lending rate to a range of zero to 0.25 percent in December 2008 and have repeated after each meeting since March 2009 that borrowing costs will stay “exceptionally low” for an “extended period.”
The Fed finished buying $1.25 trillion of mortgage-backed securities in March. While some policy makers want to start unloading them soon, Bernanke has signaled no action is imminent. The purchases helped expand the Fed’s balance sheet to $2.34 trillion as of July 14 from $876.7 billion three years ago, just before the financial crisis began.
Lawmakers say they plan to pressure the former chairman of Princeton University’s economics department in other ways. Reed’s concern encompasses a combined state budget gap of $127.4 billion, according to a June report by the Washington-based National Governors Association and National Association of State Budget Officers.
State Spending Cuts
“That’s something that’s clearly in our bailiwick more than” the Fed’s, he said, adding that spending cuts by state and local governments could slow the recovery.
Not everyone is ready to give the Fed a pass on monetary policy. Representative Carolyn Maloney of New York, who chairs the Joint Economic Committee and is the third-ranking Democrat on the House Financial Services panel, said she will question Bernanke about what else the central bank can do to boost employment.
“I worry that the inflation hawks at the Fed are not allowing him to pursue monetary policy that can spur hiring,” Maloney, 64, said in an interview. Bernanke “is creative and has a great mind for coming up with targeted and innovative options.”
Obama’s administration is fighting tension with companies after Ivan Seidenberg, chief executive officer of New York-based Verizon Communications Inc., said in a June 22 Washington speech that White House regulatory programs are discouraging job growth and creating an anti-business climate.
White House senior adviser Valerie Jarrett invited executives last week to send ideas about changing the corporate tax code, reducing the deficit and expanding trade.
“While we may disagree on some issues, we have an open door,” Jarrett wrote to Seidenberg, who is also chairman of the Washington-based Business Roundtable, an association of U.S. CEOs.
Another focus at the hearing will likely be reversing cuts in loans to small businesses, the subject of a July 12 Fed conference.
Companies with fewer than 500 workers employ about half of Americans and account for about 60 percent of gross job creation, Bernanke told the forum. One measure of banks’ loans to small businesses fell to $670 billion from $710 billion during the past two years, he said, while reserves banks hold above Fed requirements have topped $1 trillion since November.
“He’s got to figure out a way to get credit extended,” said Senator Sherrod Brown, an Ohio Democrat. “I hear from business people in my state all the time that they have the capacity, they know they can hire people and they have the orders. And they can’t get credit.”
William Dunleavy, 55, a podiatrist in Easton, Pennsylvania, laid off one of two employees this year and is considering shutting his practice, which serves 70 to 100 patients a week. Banks revoked credit lines totaling $60,000, and attempts to get other loans failed, forcing him to borrow on personal credit cards to stay afloat.
“This is the most difficult time I’ve ever seen,” Dunleavy said in a telephone interview.
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