$tarrBuck Report for July 23, 2006: What Did Chairman Bernanke Say?

July 23, 2006

$tarrBuck Report for July 23, 2006: What Did Chairman Bernanke Say?

by R. M. Starr

Last Wednesday Dr. Ben Bernanke, Chairman of the Federal Reserve Board of Governors, gave his semi-annual Humphrey-Hawkins testimony to Congress. Must have been good news! While he was speaking the Dow gained over 200 points! Of course, the stock market lost most of Wednesday’s gains during the rest of the week, but it was a really fun day. What did Chairman Bernanke say? What does it mean for you?

Wall Street was pleased because the Street interpreted Bernanke’s remarks as meaning that the Fed is very nearly done raising interest rates. That reduces the competition for stocks from the fixed-income market. How come? Aren’t there still signs of increasing inflation? Isn’t gasoline still becoming more expensive?

Bernanke noted several things:
> The Fed concentrates both on economic growth and inflation.
> The measure of inflation the Fed concentrates on is core inflation. They purposely try not to respond to food and energy prices because those prices do not really significantly reflect US monetary policy or domestic US economic activity. The Fed’s principal concern regarding oil prices is whether energy price increases will spread to more general price inflation — possibly through catch-up wage increases.
> The Fed needs to be forward-looking. Policy actions take about a year to work through the economy. The housing market just started responding to 2004’s interest rate increases in late 2005. The economy will still be adjusting to 2006’s interest rate increases in 2007.
> US economic growth is expected to slow down in the second half of 2006. Slowing economic activity tends to slow price increases (with a time lag) so an anti-inflation monetary policy is already in place.
> The Fed is concerned both with actual inflation and inflationary expectations. Expectations can enter price and wage decisions. So far, inflationary expectations are under control.

Bottom line. Bernanke didn’t promise to stop raising interest rates, but he gave a really broad hint. A slowing economy with low inflation expectations still absorbing the two past years’ of interest rate increases doesn’t need any additional monetary restraint. The last Federal Funds rate target increase (in June) or the next (in August) will probably be the final increase for the foreseeable future.

That’s good news if you hold long bonds, owe an adjustable rate mortgage, or if you own preferred or common stocks. It’s not so good if you’re a saver in CD’s, a savings account, or Treasury bills; you might have wanted a few more rate increases to juice your return.

Wall Street enjoyed the news for at least one day.

(c) Copyright R. M. Starr 2006

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