Investors have been nervous recently about whether the U.S. Federal Reserve may be sending out clues that interest rate increases are coming.
If they’re hoping to get more clarity from Fed Chairman Ben Bernanke this week, they are likely to be disappointed.
The Fed last week increased the rate charged to banks on emergency loans, which markets took as a sign that tighter credit across the economy may be the next step. Since then, Fed officials have been saying they’re not sure when borrowing costs for consumers and companies could also rise.
Bernanke is expected to make the same point when he delivers his semiannual monetary policy report to Congress on Wednesday, stressing to lawmakers that the rise in the discount rate doesn’t mean the Fed’s key short-term interest rate will also rise soon.
The path of the Fed funds target rate at which banks lend to each other overnight depends on how the recovery unfolds, the central bank chief will probably say. And that remains a very tough call to make.
Emerging from its worst recession since World War II, the U.S. economy grew sharply at the end of 2009 as business inventories surged. But a key growth engine like consumer spending is expected to remain constrained by high unemployment throughout 2010. Meanwhile, consumer prices net of volatile energy and food items in January dropped for the first time since 1982, a sign of weakness for the economy at the start of 2010.
Fed officials see the jobless rate staying at a high level of around 9.5% in the final quarter of 2010 and inflation at a low level of around 1.5% in that same time period, according to the latest projections a month ago from the bank’s policy-making arm. Bernanke is expected to use the same forecasts in his testimony to the House Financial Services Committee Wednesday. The Fed chairman is to present the same report to a Senate committee Thursday.
So far this year, the Fed’s forecasts have highlighted questions about the economy’s outlook. Central bank officials said after their latest Jan. 26-27 meeting that uncertainty surrounding their predictions on unemployment and inflation was “unusually high relative to historical norms.”
Fed Vice Chairman Donald Kohn told bankers last month that monetary policy was in “unchartered waters,” warning investors need to start preparing now for the risk that interest rates could move swiftly in unexpected directions, most likely up.
Like Kohn, Bernanke may warn that there is a long list of factors that can affect the rate outlook, including a rising budget deficit, foreign demand for U.S. debt and the strength of the recovery.
But he’s unlikely to provide more information beyond the standard line that the central bank expects to keep the Fed funds target close to zero for an “extended period”–generally understood to mean at least several months–due to a soft recovery.
Bernanke is likely to echo what Fed officials have been saying since the discount rate was increased by a quarter-point to 0.75% on Feb. 18–that the move was just a “further normalization” of its emergency-lending programs thanks to improvements in financial markets.
Many investors saw the move as a first step toward tighter credit, with the U.S. dollar rising against major currencies on expectations the Fed will raise rates before other major central banks.
To signal that no tightening in credit is around the corner, the Fed chief may point to continued weakness in the economy, especially an unemployment rate that is seen still around 8.5% at the end of 2011.
With the U.S. economy continuing to shed jobs, a main focus of the hearing will be to examine policy options available to the Fed to meet its mandate of fostering maximum employment, the House Financial Services Committee said in a memo to staff.
Nonfarm payrolls fell by 20,000 in January after a 150,000 drop in December 2009, a government report showed earlier this month. The unemployment rate, which is calculated using a separate government survey, fell to 9.7% in January from 10% the previous month.
In testimony Tuesday, economists told the House committee the U.S. labor market remains so weak that both the Fed and Congress must be ready to provide additional stimulus.
“The Fed must not raise interest rates too soon and remain flexible with regard to renewed use of credit easing later this year,” said Mark Zandi, economist at Moody’s Analytics who advises Congressional Democrats.
He said Congress should also provide more resources–to unemployed workers whose benefits are running out, to small businesses looking for credit and to all companies that expand payrolls.
Although Bernanke will want to stress the economy still needs the Fed’s support, he’s expected to lay out the central bank’s plans for when the recovery will be strong enough to withstand higher rates on consumer and business loans.
A first step toward tighter credit could involve the Fed draining the more than $1.0 trillion in excess reserves banks have accumulated after the central bank bought mortgage-backed securities and U.S. Treasurys to combat the financial crisis. That would be done via market operations known as reverse repurchase agreements and term-deposits.
Bernanke said earlier this month the 0.25% rate the Fed charges banks on excess reserves may for a time replace the Fed funds target rate as the main tool to tighten credit.
In what could take up a lot of the questions and answers session, House committee members are expected to grill the Fed chief on the financial crisis and proposals to overhaul financial regulation to prevent another one.
The House approved a financial regulation bill Dec. 11 that would expose the Fed’s interest-rate decisions to unprecedented congressional scrutiny. Meantime, the Senate is proposing to strip the Fed of its regulatory powers over banks, after some Senators accused Bernanke of failing to see the crisis was coming.
Responding to the criticism, Bernanke could toe the line he took when he was sworn in for his second-year term earlier this month: protecting the central bank’s independence from political interference is crucial for the economy–especially at such a difficult crossroad.
By Luca Di Leo – wsj.com
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