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I Think Bernanke Just Indicated a Tightening

Posted by Larry Doyle on February 10, 2010 10:52 AM |

Fed Chair Ben Bernanke

Fed Chair Ben Bernanke

I think Fed Chair Ben Bernanke just sent a very clear sign that he is getting ready to start tightening monetary policy.

Be mindful that Bernanke, as with every Fed chair, chooses his wording very carefully. While many market strategists and economists seem to be dismissive of Bernanke’s comments this morning, I beg to differ. The fact that Bernanke used the phrase “before long” in regard to his view on a shift in the discount rate is a very clear sign that he will soon start to raise selected rates.

How did Bernanke deliver this message?

Bernanke submitted written testimony to the House Financial Services Committee this morning. Bloomberg reports,  Bernanke Says Fed May Opt to Raise Discount Rate ‘Before Long’:

The Federal Reserve may raise the discount rate “before long” as part of the “normalization” of Fed lending, a move that won’t signal any change in the outlook for monetary policy, Chairman Ben S. Bernanke said.

Bernanke repeated the Federal Open Market Committee statement that low rates are warranted “for an extended period” in testimony prepared for the House Financial Services Committee. The Fed may also temporarily replace the federal funds rate as a policy guide with interest it pays on banks’ deposits should fed funds become a “less reliable indicator than usual,” Bernanke said.

Bernanke, who this month started his second four-year term as Fed chief, previewed what would be the first interest-rate move in more than a year while giving more details on several tools that may be used to tighten credit “at some point.” Bernanke, 56, and his fellow policy makers are preparing to remove unprecedented monetary stimulus as the U.S. economy is forecast to grow at the fastest pace since 2006.

“Before long, we expect to consider a modest increase in the spread between the discount rate and the target federal funds rate,” Bernanke said in the testimony for a hearing originally scheduled for today and postponed because of a snowstorm. A new date hasn’t been announced.

The changes “are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for monetary policy, which remains about as it was at the time of the January meeting of the FOMC,” Bernanke said.

Not surprisingly, Bernanke tries to downplay the potential impact of this increase in the discount rate. I’m not buying it.

Rest assured, just as night follows day, watch banks raise other rates of interest in sympathy with the shift higher in the discount rate.

How are markets reacting to Bernanke’s statement?

1. The dollar is stronger.
2. Equities are weaker.
3. The yield curve is flattening. (Short term rates slightly higher, long term rates slightly lower).

Will these trends continue? Well, as a mentor of mine once told me, when the Fed raises rates, rates go up. Higher rates may not occur immediately, but they will move higher and be a headwind for our economy and our markets.


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