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Why Bernanke Faces Stiff Headwinds

Credit tightens, inflation rises as businesses and households feel scant relief from the Fed's rate cuts. That doesn't bode well for recovery

So far in 2008, little seems to be going right for the U.S. economy or for the Federal Reserve's efforts to keep it on course. In fact two very important things are going in the wrong direction: inflation and long-term interest rates. The price of oil was expected to level off or decline by now, not soar back to $100 per barrel, and slower growth was supposed to keep a lid on other prices. Instead, inflation in January picked up steam, even outside of energy. More importantly, while the Fed's January cuts, unprecedented in their size and speed, were supposed to ease borrowing conditions for businesses and home buyers, credit has tightened further.

During his semiannual testimony before Congress on Feb. 27-28, Fed Chairman Ben Bernanke said nothing to dampen expectations of further rate cuts. However events appear to be overtaking the Fed as its policy-easing struggles to show results. Credit tightening is spreading beyond subprime-related financial instruments to the debt offerings of healthy companies and prime mortgage borrowers. The danger, as policymakers said in the minutes of the Fed's last meeting, is an "adverse feedback loop."