The Hindu Business Line : Ben Bernanke’s moment of truth?

It’s crunch time for the Federal Open Market Committee (FOMC). The US interest rate-setting body met on August 7. Every one of the economists surveyed before the meeting thought there would be no change in interest rates.

So what is the excitement? Actually, there is no interest in the FOMC’s rate decision, which is a given, but only in its take on the recent upheavals in US financial markets. Till the meeting, Dr Ben Bernanke and his colleagues have not given up their stance of inflation still being a ‘risk’.

But can the Fed ignore the mayhem in credit markets, which, last week, spread to stocks and engineered a 700-point fall in the Dow? Strictly speaking, the behaviour of stock markets is none of the business of a central bank. But in the last couple of decades, a new bonding is developing between markets and the economy. If the market sneezes, the economy could catch a cold.

Mr Greenspan recognised this connectivity and thought something should be done about it. In the several market crises during his 18-year tenure as Fed Chairman, he was quick to cut interest rates in response and flood the market with enough and more liquidity.

‘Greenspan put’

So proactive was he that his actions have gone into market lore as the ‘Greenspan put’. The market could count on the Fed cutting rates if things went seriously wrong.

Do Dr Bernanke and the FOMC endorse the ‘Greenspan put’? The market does not know. Hence, a guessing game is on.

Weak economy

They are still straws in the wind but the collapse of credit markets has coincided with somewhat weaker economic data. Only 92,000 non-farm jobs were added in July – far below the forecast of 1,32,000. Previous months’ figures were also revised downward. Besides, the ISM indices of manufacturing and services fell (although they are still above 50, below which the reading is recession – indicative). Retail sales, ex-auto, were in negative growth territory.

Thus, the fall in Treasury bond yields is not only a result of the problems in credit markets but also possibly a reflection of the distinct prospect of an economic slowdown.

The Fed will act to rescue a weak economy but not weak markets is the current message from monetary policy makers.

Will the customary post-meeting statement talk only about inflation risk or go beyond? At the last meeting, the view was that housing and subprime mortgages, although negative influences, will not push the economy into recession.

Chances are that the Fed will at least slightly tone down its anti-inflation rhetoric and express confidence that markets will weather the storm.

Dr Bernanke’s Fed is not yet ready to concede there is a contagious link between markets and the economy.

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