Financial Daily from THE HINDU group of publications
Wednesday, Jun 07, 2006
Financial Daily from THE HINDU group of publications Wednesday, Jun 07, 2006 |
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Money & Banking
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Insight Columns - Financial Scan Bernanke spooks markets S. Balakrishnan
The market seems to be looking for that reassurance, especially after his recent Congressional testimony that the Fed may adopt a `wait-and-watch' stance on interest rates.
Falling growth and rising inflation - a dreaded combination which goes by the name of stagflation. Just a couple of months into his term as Chairman of the US Federal Reserve, Mr Ben Bernanke, faces difficult challenges. May saw a sharp sell-off in global markets. But it was not cataclysmic. Mr Bernanke's Fed did not have to bring out its armoury of slashing interest rates and pumping liquidity to salvage the situation. The news on the job front was not good. For May, non-farm payroll increased just 75,000 and previous estimates were revised downwards. Still, it was welcome news to those who fretted that a hot employment market would lead to wage-price inflation. 10-year bond yields promptly crashed to sub-5 per cent levels as the conviction grew that the Fed will take a breather from increasing interest rates yet again at its next meeting in end-June.
Little cheer for economy
But Mr Bernanke put spokes in the case for a pause. In his speech on Monday (which sent Wall Street reeling), there was little cheer for both economy and inflation-watchers. Growth is slowing but the inflation picture is none too bright. There is the risk of pass through of rising energy and commodity prices. Recent data on core inflation, i.e. excluding food and energy, are not comforting. They are running a little ahead of the Fed's target of 2 per cent. Mr Bernanke left hardly any doubt that he was tough on inflation and would back up words with action. The market seems to be looking for that reassurance, especially after his recent Congressional testimony that the Fed may adopt a `wait-and-watch' stance on interest rates.
On probation
Mr Bernanke is on probation and he knows it. His recent utterances are designed to bolster the credibility of the Bernanke-led Fed. It is not just a matter of achieving and maintaining price stability but being seen as ready to pre-empt inflation expectations. As any central banker knows, credibility is hard won but easily lost.
Immediate response
The market response to Mr Bernanke's speech was immediate and significant. Bond yields did rise but more at the short end - a good sign because this would not have happened unless the market believed the long-term outlook is inflation-friendly. The basic issues will, however, not go away. Has the Fed already gone overboard with its rate rises? Will the economy pay the price with a marked declaration in the coming months? Will the inflation danger turn out to be a mirage? Clearly, interest rate decisions are not costless (for the real economy, that is, not central bankers!). The markets can only hope that either by design or accident, the Fed gets it right.
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