Markets remain jittery
ahead of Tuesday and Wednesday's Federal Open Market Committee meeting.
Chairman Ben S. Bernanke has to convince investors the Federal Reserve can take back more than $1 trillion it pumped into the U.S. banking system to pull the economy out of the longest decline in more than six decades.
...�The markets don�t understand the Fed�s exit strategy; they�re confused,� said Lyle Gramley, a senior economic adviser with New York-based Soleil Securities Corp. and former central- bank governor. �That�s contributed to the rise in long-term rates.�
The risk is that higher rates will hold back the budding economic recovery by lifting borrowing costs for homeowners and buyers. Economists surveyed by Bloomberg forecast growth of 0.5 percent in the third quarter after gross domestic product shrank for four consecutive quarters -- the first time that�s happened since 1947.
�It�s not good for the economy,� said Michael Feroli, a former Fed official who�s now an economist at JPMorgan Chase & Co. in New York. �It pushes back the housing rebound.�
The yield on the 10-year Treasury note ended trading at 3.78 percent June 19, up from 2.21 percent at the end 2008.
The average 30-year mortgage rate rose to 5.59 percent earlier this month, the highest since November, before slipping to 5.38 percent in the week ended June 18, according to Freddie Mac, the McLean, Virginia-based mortgage-finance company.
It doesn't help that the Treasury is pushing another $104 billion of supply
into the bond market this week either. �Increased supply of bonds will of course push down bond prices and thus push up bond yields, carrying other interest rates with them.
Now Paul Krugman is arguing hard
against the view that deficits are pushing up interest rates. �But he hand-waves the exchange rate issue (in the first link.) �OK, so let's look at spot commodity prices
. �While they've drifted a bit over the last few weeks, there's no doubt they are above their March levels. �Wouldn't that be because of inflation fears? �I think you'd be hard pressed to find Fed officials who don't at least think there's inflation possible here. �So does Kansas City Fed president Thomas Hoenig
As soon as you introduce methods to deal with the crisis, as we did, that are out of the norm, you should very quickly begin to think about what your exit strategy is. And that is the process we are in right now and we're thinking it through...
We have put an enormous amount of liquidity into the system ... If it is allowed to remain indefinitely, and we keep a very low (interest) rate for an extended period of time, then we do risk an inflationary outbreak.
So this puts the Fed in a bit of a box this week. While tightening now is probably not in the cards, there may come a time they want to do so. �Failure to signal this week that the value of the dollar is a concern to them -- one they are willing to invest in -- will probably start the process of higher inflation. �Either higher nominal rates (through higher inflationary expectations) or higher real rates (in defense of the dollar) means the interest rate cycle has begun the process back up, which is bad news for housing.
Labels: economics, Federal Reserve