Bernanke Avoids Pledging Action Even as Outlook `Uncertain'
Federal Reserve Chairman Ben S. Bernanke signaled that signs of deeper economic weakness would be needed to justify additional monetary stimulus, even as he said there’s an “unusually uncertain” outlook for growth.
The Fed’s near-zero interest rates and record balance sheet are already “very stimulative,” Bernanke said yesterday in Senate testimony. He outlined possible options “if the recovery seems to be faltering,” including amplifying the commitment to low borrowing costs, while cautioning that officials haven’t fully reviewed the measures.
Bernanke’s comments, including a reiteration that the Fed is planning for an exit from its unprecedented stimulus, sent stocks tumbling from Wall Street to Tokyo. While Bernanke left the door open to additional steps, he said nothing would happen in the “near term.”
“We’d have to be staring at a more significant redevelopment of financial crises or a more detrimental downturn in activity to provoke a significant policy response,” said Keith Hembre, chief economist at U.S. Bancorp’s FAF Advisors Inc. in Minneapolis and a former Fed researcher. “That’s probably a disappointment to some in the market that anticipate that every time when the market isn’t continuing to steadily go up it requires policy makers to do something,” said Hembre, whose firm oversees more than $91 billion.
The Fed chief devoted a bigger portion of his prepared testimony to how the Fed would eventually withdraw its unprecedented credit expansion.
The Standard & Poor’s 500 Index of stocks dropped 1.3 percent to 1,069.59 at the 4 p.m. close of trading in New York. Yields on two-year Treasury securities fell to 0.552 percent, the fourth record low in five days as investors put off expectations for the Fed to raise borrowing costs. In Tokyo, the Nikkei 225 Stock Average fell 0.6 percent.
Bernanke’s semiannual testimony on monetary policy concludes today with a 9:30 a.m. hearing before the House Financial Services Committee in Washington.
“We’re not prepared to take any specific steps in the near term, particularly since we’re still also evaluating the recovery, the strength of the recovery,” Bernanke said under questioning from lawmakers at the Senate Banking Committee.
Former Fed Governor Lawrence Lindsey predicted that the U.S. central bank will take additional easing steps by the end of the year.
“It would be obvious for the Federal Reserve by the end of this year that we are entering in a deflationary trap and I would expect some response by the Fed by that time,” Lindsey, who also served as a White House economic adviser in the Bush administration in 2001-2003 and now runs his own consulting company, said at a forum in Tokyo today.
Among the options outlined by Bernanke during questioning would be to alter the Fed’s “language or our framework describing how we intend to change interest rates over time, giving more information about that,” potentially using a strategy adopted by the Bank of Canada last year.
The Fed has repeated since March 2009 its commitment to keep the benchmark federal funds rate very low for an “extended period” without specifying how long that would be. The Bank of Canada gave a timeframe for keeping rates low.
Bernanke’s comments on the economy and monetary policy showed little change from minutes of the Fed’s June 22-23 meeting, which said officials would need to consider options should the economic outlook “worsen appreciably.”
In August 2007, with the subprime-mortgage market collapsing, Bernanke and his colleagues judged that inflation was their “predominant” concern and left their benchmark interest rate at 5.25 percent. Within two months, they had scrapped that view and begun cutting rates. That December, the worst recession since the 1930s began, and a year later, the federal funds rate was cut almost to zero.
This year, while the economy is growing, recent data have prompted analysts to cut their forecasts. In June, U.S. factory output fell 0.4 percent, the most in a year, housing starts declined to the lowest level in eight months and private employers added fewer workers to payrolls than economists forecast.
The average growth in private payrolls of 100,000 a month so far this year is “insufficient to reduce the unemployment rate materially,” and it will probably take a “significant amount of time” to restore the almost 8.5 million jobs lost in 2008 and 2009, Bernanke said.
“I do think the Fed chairman is too complacent,” said John Makin, a visiting scholar at the American Enterprise Institute in Washington and principal at hedge fund Caxton Associates LLC. “It appears the Fed’s internal model is not calling for a slowdown, and so he is sticking with that.”
Fed policy makers trimmed their forecasts for U.S. growth and raised unemployment projections at their June meeting. For 2011, officials expect growth ranging from 3.5 percent to 4.2 percent, down from 3.4 percent to 4.5 percent, and a fourth- quarter unemployment rate of 8.3 percent to 8.7 percent, up from 8.1 percent to 8.5 percent.
Those projections “look very stale,” said Hembre.
Makin said Bernanke should “pledge to keep the fed funds rate at zero for two years.”
In April 2009, the Bank of Canada cut its key rate to a record 0.25 percent and vowed to keep it there until the second quarter of this year, “conditional on the outlook for inflation.” It raised borrowing costs in June.
Outlook for Rates
The first rate increase by the Fed could occur as soon as the second quarter of next year, according to the median estimate in a Bloomberg News survey in early July. A more specific time commitment from the Fed might reduce yields on Treasury notes, cheapening financing costs for millions of businesses and consumers.
The move also wouldn’t require the Fed to expand its $2.34 trillion balance sheet or allocate more credit to industries such as housing, a move some policy makers oppose. The Fed has already purchased about $1.25 trillion of agency mortgage-backed securities to lower home-loan costs.
Another possible step, Bernanke said, is restarting securities purchases after the Fed bought $1.7 trillion of housing debt and Treasuries through March 2010. Fed officials have been debating this year the timing and pace of selling the mortgage securities.
Interest on Reserves
The Fed could also lower the 0.25 percent interest rate it pays on the $1 trillion of deposits held there by banks, Bernanke said.
Reducing the interest rate on reserves would be “more problematic than stimulative,” Joseph Abate, a money-market strategist at Barclays Capital Inc. in New York and former Fed researcher, said in a report.
A reduction would lower yields as banks used their reserves to buy Treasury securities, encouraging the departure of $500 billion in deposits from money-market mutual funds, Abate said.
“Clearly each of these options has got drawbacks, potential costs,” Bernanke said. “I do think that there is some potential for some of those steps to be effective.”
With the average U.S. rate on a 30-year home loan at a record low 4.57 percent for the week ended July 15, Fed officials have been focusing on ways outside of monetary policy to aid the economy, such as encouraging lending to small businesses.
The Fed is saying, “We can muddle through here,” said John Canally Jr., investment strategist and economist at LPL Financial Corp. in Boston, which oversees $285 billion.