Ben Bernanke doesn't commit Fed to more action

9:36 AM, Aug 31, 2012   |    comments
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By Paul Davidson, USA TODAY

In a highly anticipated speech Friday, Federal Reserve Chairman Ben Bernanke Friday called "the stagnation of the labor market in particular a grave concern," reiterating that the Fed is prepared to do more to stimulate stronger growth.

"We must not lose sight of the daunting economic challenges that confront our nation," Bernanke said in a speech at the Kansas City Fed's annual symposium that attracts an elite group of global central bankers and prominent economists.

However, Bernanke may have disappointed Wall Street's hopes in giving no clear signal that the Fed will take action at its mid-September meeting. Yet, after having time to digest all of Bernanke's remarks, investors appear to have taken comfort in Bernanke's willingness to take action as needed.

In the speech, Bernanke said "the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability."

That language echoes the Fed's statement after its early August policy making meeting and reflects a stronger inclination than it had conveyed in previous statements to take action if the economy doesn't pick up noticeably.

Many economists believe the Fed likely will decide to buy more Treasury or mortgage-backed securities, possibly at its Sept. 12-13 meeting, to lower long-term interest rates and spark more economic activity. Alternatively, it could promise to keep short-term interest rates near zero longer.

Yet while Bernanke left the door open to such action soon, he stopped short of telegraphing the timing of any further action that many investors and Fed watchers were seeking.

At a meeting in Jackson Hole two years ago, Bernanke strongly hinted the Fed was poised to buy more Treasury bonds, a strategy that lowered rates well before the Fed actually voted two months later to purchase $600 billion in Treasuries.

A similar foreshadowing this year seemed possible. At its meeting early this month, many Fed policymakers determined that additional stimulus would be needed unless economic data "pointed to a substantial and sustainable strengthening in the pace of economic recovery," according to minutes of the meeting.

While growth remains subpar three years into the economic recovery, the latest round of economic reports have been mixed. In July, employers added a better-than-expected 163,000 jobs, consumer spending picked up and pending home sales climbed to the highest level in two years.

At the same time, manufacturing activity has weakened recently, consumer confidence in August fell to its lowest level in 10 months and second-quarter economic growth was revised up slightly last week to a still-tepid 1.7% annual rate.
In his speech, Bernanke called job growth "painfully slow." New jobs created slowed from a monthly average pace of 226,000 the first quarter to 73,000 a month on average in the second quarter. He said obstacles to a stronger recovery include a weak housing market despite recent signs of life, the European financial crisis, tight credit standards and looming federal tax increases and spending cuts in January that could push the U.S. back into recession if a divided Congress can't agree on how to mitigate their impact.

Bernanke also said further Fed action could help the economy because there's little evidence that the slow decline in the unemployment rate - now at 8.3% - reflects structural labor-market problems that would be immune to Fed action. Structural problems could include a high number of laid-off manufacturing or construction workers who lack skills needed for new high-tech or health care jobs.

Still, the Fed chair said such costs "appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant."

Bernanke also cited studies showing that the Fed's previous initiatives to buy more than $2 trillion in government securities have lowered yields on 10-year Treasuries by about a percentage point. Thus, they are effective in lowering borrowing costs for consumers and small businesses.

Even so, Bernanke pointed out that "the possible benefits" of more asset purchases "must be considered alongside its potential costs." For example, he said, the Fed could stoke inflation or become too dominant a player in the market, damping private trading.

Addressing the Fed's risk of stoking inflation, many Fed watchers say, is for the Fed to buy mortgage-backed securities, rather than Treasuries, to more sharply push down mortgage rates and help jump-start the housing market. However, while mortgage rates are already near historic lows, many consumers can't qualify for home loans because their existing houses are worth less than what they owe.

And a third round of stimulus would likely invite criticism from Republicans that the Fed's actions risk eventual inflation, a charge that could be particularly controversial less than 100 days before this fall's presidential election.

The Fed could take the more modest step of suggesting it will keep short-term interest rates near zero until at least 2015, placing further downward pressure on interest rates, says Jason Schenker, president of Prestige Economics. The Fed has said it expects to keep rates very low until at least late 2014.
There's no doubt that each round of Fed stimulus has had less impact than the previous one, analysts say.

Since the 2008 financial crisis, the Fed has purchased more than $2 trillion in Treasuries, mortgage-backed securities and other debt in an unprecedented effort to lower long-term rates and coax investors to shift assets to stocks, boosting markets. It decided in early 2009 to buy $1.7 trillion in Treasury and mortgage bonds, followed by the $600 billion in Treasury purchases in 2010.

Under a program begun last September - and extended in June through 2012 - the Fed plans to buy $667 billion of short-term Treasuries and use the proceeds to buy longer-term Treasuries. By reducing the supply of long-term Treasuries in the market, the Fed hopes to exert downward pressure on long-term interest rates.

Nigel Gault, chief U.S. economist of IHS Global Insight, says the recent modest uptick in economic activity isn't enough to head off another round of Fed stimulus.

"It's hard to argue that the evidence of the last month or two constitutes a substantial and sustainable improvement," Gault says.

Still, Gault says that the cloudy economic picture suggests that Fed policymakers will look closely at upcoming data, likely avoiding a commitment to additional action in September until they see more recent data, particularly the government's employment report for August, which is due out Sept. 7. The European Central Bank also could take additional steps at a Sept. 6 meeting to ease Europe's debt crisis.


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