Farrell: Bernanke Is No Fool

Do You Think Ben Reads Barron's?

I wonder what Fed Chairman Bernanke does read and if the popular press has any impact on his thinking at all. The Barron's cover storyover the weekend called on Ben to raise interest rates to "prevent the dollar from collapsing and inflation getting out of control." It would be something if asked and Ben said "what's Barron's?" That thought aside, the article calls for higher rates since the "crisis accommodative policy" that brought the Fed to lower the Fed Funds rate to only .15% is no longer needed. The economy is recovering, gold, oil and other commodities are rising, while the dollar is falling. The Fed, says Barron's, should "boost short rates to a more normal 2%... to send a signal to the markets that the U.S. is serious about supporting its beleaguered currency." "It's also time", says the author, Andrew Barry, "for the Fed to consider the plight of the country's savers..who are being forced to take substantial interest rate or credit risk if they want higher yields.. there are millions of Americans — most of them elderly — who diligently saved and now have little income to show for a lifetime of effort."

Ben Bernanke
Ben Bernanke

Good arguments all, but not likely to spur the Fed to action.

Higher short rates would push mortgage rates up and the housing market is such a Washington focus that such a move would be more than noticed.

The Vice Chairman of the Fed, Donald Kohn, recently said in a speech that rates needn't go up until the unemployment rate improved.

In a lengthy talk he referred to what most consider a mistake the Fed made in 1937 when it turns out rates were prematurely raised and the then recovering economy collapsed again.

  • Producer Prices, Housing Starts Post Surprise Drops

Writing on Monday, John Kilduff and Mike Fitzpatrick, the energy gurus at MF Global said "Propelled by speculative interests taking advantage of ample liquidity, low interest rates, a falling dollar, and a healthy skepticism relative to both debt and equity instruments have flocked to commodities, especially oil." The dollar is off about 1/3 this decade against a basket of currencies. Most don't think there would be a crisis declared without the stock and bond markets falling significantly, and those markets have done well. But the Fed's job is to take the punch bowl away from the party before it gets out of hand. I worry that we will stay too loose, for too long, and, in my mind, defending your currency is paramount (but that is not the Fed's job — see below). I don't look for any near term Fed moves with the export markets being helped (especially in the industrial heartland where there will be a lot of contested elections) and the housing market still so fragile.

But Ben is no fool. Apparently the New York Fed again engaged in reverse repo tests. Reverse repos drain liquidity and the Fed said the tests were "a matter of prudent advanced planning..no inference should be drawn about timing..this tool will be ready." Is Ben getting ready for an earlier move than most expect? As I wrote last week, the Fed doesn't need to test for repos. They have done them forever. I would like to think there is a message here.

Soleil's chief economic advisor, former Fed Governor Lyle Gramley, notes the Federal Reserve has the legal mandate to maximize employment and to promote price stability, not to defend the dollar. 7.2 million jobs have been lost since the recession began so the Fed's job is still ahead of them in that regard. "Core" CPI inflation is up only 1.5% year over year and Lyle thinks that is at the low end of Fed tolerance. If growth were to be way stronger than the expected 3% or so; if inflation expectations were to worsen (therefore questioning the Fed's inflation fighting credentials); if wage rates were to move up suddenly; or if the dollar went into free fall and the Treasury leaned on the Fed to join it in some kind of intervention, then rates might move. Otherwise, Lyle feels it will be more towards 2011 before rates are raised.

While the bulk of earnings reports will be made in this and subsequent weeks, the data so far is encouraging. Reuters reports that 79% of companies reporting so far have beaten earnings estimates and 60% have beaten revenue estimates. The international markets are especially showing strength. Companies though are still hesitant to hire and to commit to capital expansion. While revenues are better than carefully guided estimates, they are still down significantly against last year.

I normally finish writing this letter in the early evening for overnight distribution. I was going to talk about the answer to the ultimate question in the Universe, but it's now almost 4 PM and the Yankee game comes on in 15 minutes. Priorities!