Crescenzi: Bernanke—Escape Velocity Nearer

Bernanke’s testimony before the Joint Economic Committee is littered more with optimism than headlines regarding his speech suggest, and there was no use in the text of the “extended period” language until it was uttered during the question and answer session, when it helped the bond market to rebound. The use of the phrase "extended period" in many eyes means that the Fed will be on hold for quite some time, possibly for at least six months.

Notable in Bernanke's testimony in particular is his discussion of the sources-of-growth handoff, which PIMCO's Mohamed El-Erian has described in terms of a 3-stage rocket booster. The first stage of course is fiscal and monetary stimulus. The second is inventory investment. The third, and the one that gives the U.S. economy escape velocity is private-sector demand. Bernanke discussed this “handoff” concept precisely in these terms:

“With inventories now better aligned with final sales, however, and with the support from fiscal policy set to diminish in the coming year, further expansion will depend on continued growth in private final demand.”

US Federal Reserve Board Chairman Ben S. Bernanke
US Federal Reserve Board Chairman Ben S. Bernanke

Importantly, Bernanke indicated that he felt the U.S. was tentatively achieving escape velocity:

“On balance, the incoming data suggest that growth in private final demand will be sufficient to promote a moderate economic recovery in coming quarters.”

Bernanke’s use of the word “moderate” does not negate the importance of the statement because when a full-fledged self-reinforcing recovery is achieved it will probably be sufficient for an eventual change in monetary policy, particularly because the Fed's zero-rate policy is meant to address a much different environment. When Bernanke is more confident, out will go the “extended period” phrase, which has already been watered down a bit in terms of its linkage to a time element, with the Fed having conditionalized the phrase in its March 16th FOMC statement.

Important also in the speech was Bernanke addressing three core principles behind the concept of headwinds: income growth, wealth destruction, and credit availability. In my notes, I personally have cited these three headwinds together when describing the main headwinds to vigorous economic growth. On these important issues, Bernanke addressed each in one sentence:

“Going forward, consumer spending should be aided by a gradual pickup in jobs and earnings, the recovery in household wealth from recent lows, and some improvement in credit availability.”

Again, the use of a modifier—“gradual”—does not negate the implications of the statement; changes in language and an eventual change in policy will result if the conditions Bernanke describes becomes entrenched. This is all in the context of ZIRP, of course.

Headlines indicating Bernanke sees “significant restraints” on the pace of recovery are accurate, but the “significant restraints” remark begins with a “to be sure,” which is often a way of modifying all else that is said. Moreover, the “significant restraints” paragraph focuses on housing. The paragraph on employment, which is exceedingly more important, focuses first on “encouraging signs.” Bernanke nevertheless repeats an important concept; the long-term unemployed:

“I am particularly concerned about the fact that, in March, 44 percent of the unemployed had been without a job for six months or more.”

Concerns expressed in this realm show recognition toward the structural headwinds that will limit the magnitude of employment gains when all is said and done.

Interestingly the only use of the word “headwind” was to describe one that had diminished” financial conditions. The emphasis is what is important here.

A subtle evolution is the way to describe Bernanke’s description of the economy. It is not enough to augur a change in monetary policy, but it is moving closer to the point where it will mean a language change, and on March 16th there arguably was one, of sorts, with emphasis placed more on conditions than time in terms of what “extended period” truly means. This evolution need be watched carefully and FOMC members will indicate by use of common phraseology whether changes are in the offing. Data will dictate such, and data continue to move inexorably in that direction. Escape velocity is nearer, Bernanke said, although the many structural headwinds that exist in the U.S. economy suggest when it is achieved the ship will stay marginally in orbit. Still, when a self-reinforcing recovery is achieved, the implications are that the first stage of the rocket booster won’t be needed, and at that point a change in monetary policy will be in the offing.

Tony Crescenzi is Senior VP, Strategist, Portfolio Manager Pimco. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."