Bernanke Moves Markets, but Caution is Still Prudent

The power of Federal Reserve Board (“Fed”) pronouncements on financial markets was evident again. Mr.Bernanke’s apparently soothing words about the future course of interest rates in his latest testimony before the Senate banking Committee (July 18th) triggered an immediate rally in the stock market. The Dow Jones Index rose by nearly 180 points in morning trading on July 19th and Treasury Bonds recovered from earlier losses.

What did he actually say? This is the gist: although he was still concerned about inflation (higher energy and commodity prices), slowdown in economic growth would reduce price pressures in the
U.S. economy in the coming months. He also suggested that recent hikes in the Federal Funds Rate are beginning to reduce inflation risk down the road.

The financial markets interpreted Mr. Bernanke’s statements as a hint that the Fed may be coming close to ending its series of interest rate hikes. This interpretation may be a bit premature and Mr. Bernanke confirmed that by saying inflation risks are still very much present and the future course of interest rates depend on actual data on inflation and economic growth over the coming weeks.

Here are some recent economic data that, in my opinion, suggests that the evidence is mixed, we need more data, and the situation needs careful watching:

1. According to the U.S. Labor Department, the CPI in June increased by only 0.2%, the smallest increase since last February. However, the core rate of inflation (CPI minus energy and food prices) increased by 0.3% in June – higher than the CPI.

2. My concern is that core inflation is rising at an annual rate of 3.6%–significantly higher than the “comfort level” core rate of 2.0% annually.

3. The housing industry continues to slow down. The latest Commerce Department data on new home construction declined by 5.3% in June—we need to look at July and August construction before we can suggest a significant trend.

Undoubtedly Mr. Bernanke’s recent testimony to the Senate Banking Committee was encouraging, but the spasmodic one-day response of the stock market to the Fed Chair’s statement does not suggest that the economy is out of the woods. In light of the serious current geopolitical concerns in the
Middle East and the possibility of continued price volatility in the energy markets, jumping to conclusions about the future course of the economy from a “one day wonder” in our stock market is foolhardy at best.

 

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