Fed Chairman Ben Bernanke is not carrying out Teddy Roosevelt's dictum. Instead, it might be more accurate to claim he has no stick, but is talking loudly and strongly. Bernanke's strategy reflects the Fed's lack of satisfactory policy alternatives for fighting recession and credit market problems, while trying to contain inflation pressures. It is very difficult to imagine the Fed raising interest rates to fight inflation when economic problems need to remain the Fed's primary concern.
Credit problems remain, while economic growth remains sluggish. As Bernanke stated at the Boston Fed conference, the risks to the economy remain to the downside. Growth is still positive, as measured by GDP, but unemployment has surged, payrolls have declined for five consecutive months, and the housing market has not yet visibly hit bottom by any measure. Were the funds rate not already at 2%, it is easy to imagine many people would expect or want the Fed to lower interest rates. At 2%, it is fair to judge that the Fed has already implemented the steps needed to help the economy in time.
So, why is the possibility of a rate hike being considered? Were energy and food prices not rising sharply, why would anyone think that inflation is a problem? Wage rates have not taken off. Prices other than food and energy remain surprisingly stable, as the weak economy limits the ability of firms to pass along their higher energy costs. The only sign of inflation, which makes very good headlines, is the surge in food and fuel. The dollar has played a role in this rise in commodity costs and import prices, but it is just one of many factors at work. Of course, the Fed does not want this rise in commodity prices to spread to other parts of the economy and become embedded in inflation expectations. Fair enough. So Bernanke will talk up the possibility of the Fed responding aggressively to inflation, but actually raising rates makes little sense.
In fact, the Fed still needs to shore up the housing market, which will not be helped by the recent rise in interest rates, as investors repriced for the possibility of rate hikes. Even worse, mortgage rates have increased, as banks remain reluctant to make new mortgage loans even to credit worthy borrowers. Other parts of the credit market are still functioning poorly. Thus, it makes more sense for the Fed to continue working on improving credit market conditions and a pickup in economic activity, but without lowering rates to extraordinarily low levels. Bernanke may talk about containing inflation and the benefits of a stronger dollar, but he policy options are limited. Download this article in PDF Format
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Advisors Capital Management, LLC (ACM) is a provider of managed portfolios and financial services for industry professionals and their clients. As investment strategist, Dr. Lieberman oversees the company's "Portfolio Partners" investment program. Additionally, he provides guidance to the ACM Wealth Coordinators who integrate the work of financial advisors, financial planning, tax, estate and portfolio management professionals to build, protect, and maintain clients' wealth. Although the information included in this report has been obtained from sources Advisors Capital Management, LLC believes to be reliable; we do not guarantee its accuracy. All opinions and estimates included in this report constitute the judgment as of the dates indicated and are subject to change without notice. This report is for information purposes only and is not intended as an offer or solicitation with respect to the purchase or sale of any security.
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