Preview of Humphrey-Hawkins Testimony

July 20, 2010

On Wednesday and Thursday, Fed Chairman Ben Bernanke briefs both houses of Congress on U.S. economic conditions and prospects for monetary policy.  This semi-annual ritual, formerly known as the Humphrey-Hawkins hearings, always has market-moving potential. 

One year ago in July 2009, Bernanke spoke about tentative signs of stabilization in the economy amid continuing dangers.  A sustained recovery was not yet at hand.  It would be premature for the Fed to begin implementing an exit strategy, and he declined to pass judgment on whether another fiscal stimulus would be advisable.  Indeed, he observed that the impact of the first fiscal package could not yet be assessed adequately.  He assured Congress and market investors that the Fed would have the tools to reabsorb emergency liquidity.  However, they were also told to expect extended periods of low interest rates, and he listed some developments that needed to occur before exiting the accommodative stance.

  1. The Fed needs to see sustained recovery of sufficient strength to curb excess supply, known as the output gap.
  2. An improved labor market is needed.  Consumption was considered at risk because unemployment would be high for a while, and positive GDP growth would not really feel like a recovery.
  3. Signs of emerging of either inflation or expected inflation were also sought.

Treasuries rallied on the Chairman’s July 2009 testimony, but equities, which had been rallying since early March and would go on to recover substantially further, experienced a temporary setback as the Chairman began to speak.

Bernanke’s return to Congress in February 2010 gave him an opportunity to outline in detail how the Fed would be closing down emergency liquidity-supporting facilities, and he again reassured everyone that the tools were adequate to tighten monetary policy when doing that becomes appropriate.  Interest earnings on bank reserves held at the Fed would play a central role in the process, but the exact sequencing of steps and combinations of policy measures would be contingent upon the economic and financial conditions faced by officials.

Bernanke’s message last February about the U.S. economy was not dramatically improved from what he’d said in July, however.  The recovery was still nascent and required continuing policy support like low interest rates.  He felt compelled to deny that the U.S. might face a sovereign debt downgrade such as those happening in Europe.  Before raising interest rates, Bernanke wanted more evidence of labor market improvement, sustaining recovery, and diminishing downward pressure on inflation.  Note the change in the final condition from looking for accelerating inflation to an end to downward price pressure.  This shift of emphasis foreshadowed the mentioned deflation risk in FOMC minutes released last week.  Deflation had not been an explicit voiced concern for a whole year. 

Bernanke’s testimony in February pushed Treasury yields lower and stocks higher.  The dollar lost ground on signs of no central bank hurry to raise its interest rates.  Compared to the first day of testimony last February, ten-year Treasury yields are now 75 basis points lower.  The DOW, S&P 500, and Nasdaq show net losses of between 2% and 3%.  The dollar is 5% stronger against the euro but down 4.3% against the yen.

Bernanke has a delicate assignment this week.  It’s the last H-H testimony before mid-term electionsThe economy looks shakier than it did last February, and core inflation is even softer.  Unemployment is 0.6 percentage points under peak but in danger of cresting anew.  The trade deficit is rising.  There is enormous political resistance to fiscal stimulus.  The Obama poll ratings are sagging.  Americans are frustrated, and such may reflect more than a response to the economy slipping into recession at the end of 2007.

U.S. growth has been under-performing long-term trends since this century began.  After expanding by 3.0% per annum in the 1980s and 3.3% per annum in the 1990’s, growth this century has averaged 1.8% per annum and just 1.2% per annum since the end of 2004.  The U.S. is eerily following in Japan’s general footsteps, where GDP slowed from 4.4% per annum in the 1980s to 1.2% per annum in the 1990s, 0.9% per annum since Y2K and merely 0.4% per annum since end-2004.  The euro area, too, has settled for low growth.  Since the common currency bloc was formed at the end of 1998, real GDP has advanced just 1.4% per annum and is likely to post negative growth of 0.9% per annum for the three year to 2010.

The old industrialized economies are struggling in spite of intuitive supports such as the explosive development of technology applications.  Maybe that’s the problem.  Education systems aren’t geared to preparing a workforce where the job needs are evolving very rapidly, so supply/demand imbalances build faster and deeper than used to be the case.  Communication is now omnipresent and  a vehicle for magnifying any piece of negative news.  The most successful economies since Y2K have been ones where information is more closely managed.  All this is a backdrop that Bernanke will not address directly.  Without doing that, the Fed Chairman needs to give investors hope that there is an endgame to the era of slow growth and a world where very low interest rates are a sign of weakness, not economic success.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

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