The Hindu Business Line : Fed pause in the offing?

As usual, Mr Ben Bernanke's Congressional testimony a couple of weeks back evoked market-wide attention. He suggested there could be a pause in the relentless increase in the Fed's interest rate.

The fallout was immediate. Bond yields dropped as did the dollar. No heed was paid to his later comment that rates could rise after a hiatus.

The Bernanke effect continued the next day but in reverse. His casual remark to a prominent financial journalist created the impression that a pause was no done deal. Bond yields rose and the dollar too.

What's going on? Perhaps Bernanke himself does not know. The US economy is a statistician's delight, spawning out data by the dozens week after week, month after month. The reams of figures unfortunately do not point to any firm conclusion for the best of the economy and Fed-watchers.

There are those predicting strong growth which would seem to justify no near-term halt to interest rate increases. Others think the Fed has already gone too far. The latter camp has some believers in the Federal Open Market Committee (FOMC) — which sets US interest rates — judging from the minutes of the last FOMC meeting.

A crucial argument in favour of a pause is that monetary policy operates with a lag and the Fed's continuous tightening may be laying the foundation for a significant slowdown in course of time.

At the moment, the growth story is holding. Q1 GDP was over forecasts. Business and consumer confidence indices are up. Retail sales are strong. The manufacturing sector is humming.

The riddles are in housing and energy. Housing data are blowing hot and cold but with a tendency to soften. Energy is another wild card. If high gasoline prices deter the automobile-dependent American from driving as much, it has implications for consumer spending. A slowdown can then be taken as given.

Slightly compounding the Fed's worries are the latest inflation data, which showed core prices rose 0.3 per cent last month. Throw in (for what it is worth) the view that rising gold and commodity prices are a sure harbinger of higher inflation because people have lost faith in paper money and the Fed's anxiety is understandable.

Bernanke's problem is not so much what to do at the current meeting — in which Fed Funds will be moved up to 5 per cent as surely as night follows day — but what after. Should he pause because rates have gone up in every meeting in the last two years and it is time for a breather? Are commodity prices signalling inflation? How will housing behave? What are the risks in a pause vs. more increases? And what should the all-important post-meeting statement say?

Will he finally decide 5 per cent is a nice round figure for the Fed to stop and figure out what is happening?

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