Business | Banking
Bernanke could be wrong on next Fed rate
The US economy, meanwhile, may be set to take another lurch down as consumer spending gives way and the credit crunch intensifies.
- Bloomberg
- Published: 22:59 September 12, 2008
Washington, Geneva, Atlanta and Detroit: Federal Reserve Chairman Ben S. Bernanke and his fellow policy makers agreed at their August meeting that their next move on interest rates would probably be up. They may turn out to be wrong.
Inflation looks likely to ebb, thanks to falling commodity prices and contained labour costs. The US economy, meanwhile, may be set to take another lurch down as consumer spending gives way and the credit crunch intensifies with the plunge in Lehman Brothers Holdings Inc.'s shares.
"If the consumer balance sheet starts to unwind quickly, you'd get another disinflationary force and then the Fed would be brought back into play with lower rates," says Mohammed El-Erian, co-chief executive officer of Pacific Investment Management Co. in Newport Beach, California.
Bernanke and his colleagues are likely to hold their benchmark rate at 2 per cent when they meet September 16 and may keep it there until 2009, trading in federal funds futures indicates.
Still, the odds of a rate cut by year-end have been growing. As of Thursday, futures trading showed about a one-in-three chance of a December reduction, up from zero odds at the beginning of September.
San Francisco Fed President Janet Yellen left open the possibility of a rate cut in comments to reporters after a September 4 speech in Salt Lake City. "There is some chance" of easing credit "if things start going seriously wrong," she said.
She made clear, though, that she agreed with her fellow policy makers, who "generally anticipated that the next policy move would be a tightening," according to the minutes of the Fed's last meeting on August 5.
If the Fed instead ends up lowering borrowing costs, it wouldn't be the first time Bernanke and his colleagues have been forced to shift their stance from fighting inflation to supporting growth.
When the credit crisis first struck in August 2007, the Fed cut its discount rate on loans to banks just 10 days after declaring that inflation was its overriding concern.
On the edge
Investors have remained on edge since then, even after the Fed-assisted takeover of Bear Stearns Cos. in March and the rescue of Fannie Mae and Freddie Mac this month.
Shares in Lehman Brothers dropped more than 70 per cent this week as the firm reported a record $3.9 billion loss for the third quarter and concern mounted about its capital levels.
The big risk is what some at the Fed have called an "adverse feedback loop" as the credit crisis and the weak economy aggravate each other.
Now, officials also fear that another spiral could take hold as the US housing collapse and credit crunch weaken economies overseas, in turn curbing US exports.
"The balance of risks in the American economy is now towards contraction and a vicious cycle in which declining economic performance exacerbates financial strains, which feeds back to hurt the economy," Harvard University professor and former Treasury Secretary Lawrence Summers said in congressional testimony September 9.
Jan Hatzius, chief US economist at Goldman, Sachs & Co. in New York, reckons that the credit squeeze will bring the economy to a halt in the fourth quarter of this year and the first quarter of next, after growth of 2 per cent this quarter.
"The headwinds pushing against the economy look to be a good bit stronger than those experienced in the early 1990s," when the country last faced a credit crunch, Boston Fed President Eric Rosengren said in a speech September 3.
Wachovia Corp. of Charlotte, North Carolina, the fourth- largest US bank, is "tapping the brakes" on lending as credit losses mount, Chief Executive Officer Robert Steel told investors September 9.
Debt-laden consumers appear particularly vulnerable as house prices continue to fall and unemployment rises. Credit-card payments 30 or more days overdue rose to 4.7 per cent of total card debt in the second quarter, the highest level in 4 1/2 years, according to the Federal Deposit Insurance Corp.
The Fed reported in its latest regional economic survey, released September 3, that consumer spending was slow in most of the country, "with purchasing concentrated on necessary items."
Nondiscretionary outlays - including rent, taxes, food and fuel - accounted for a record 57.8 per cent of expenditures in July.
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