Interest Rate Roundup

Wednesday, February 14, 2007

More on Bernanke's comments ...

A few things stand out to me in Bernanke's testimony.

First, he said ...

“Inflation pressures appear to have abated somewhat following a run-up during the first half of 2006. Overall inflation has fallen, in large part as a result of declines in the price of crude oil. Readings on core inflation -- that is, inflation excluding the prices of food and energy--have improved modestly in recent months.”

Any surprise there? No. These are all factual statements. The implication, though, is that the Fed is less concerned about inflation than it was in the past.

Second, he said ...

“If activity expands over the next year or so at the moderate pace anticipated by the FOMC, pressures in both labor and product markets should ease modestly” and “The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks are for inflation to continue to ebb over this year and next.”

That reinforces the message no more hikes are coming any time soon. It doesn't signal rate cuts are coming, however.

But let's step back for a minute and make a note of what Bernanke did NOT say. He did NOT express any reservation about the explosion in global and U.S. liquidity. He did NOT comment on the recent re-acceleration in money supply growth (The 5.3% YOY change in December M2 was the biggest gain in 22 months). He did NOT have much of anything to say about the near-record low in credit spreads ... the explosion in leveraged buyouts ... the mania in certain emerging markets ... and more. Not so much as a "We're seeing a bit too much irrational exuberance."

I think that's a big mistake. Indeed, I'll go back to what I've been saying for months -- the Fed ignored all the high risk lending, excessive risk-taking, enormous speculation, and more in the residential real estate market. That led to the biggest bubble in housing in U.S. history, the popping of which has led to real economic and financial pain (i.e. the foreclosure surge discussed earlier)

Is the LBO market next in line for a blowup? Commercial real estate? Derivatives? Emerging market debt? Who knows? What I do know is that the Fed has got to get a handle on this excess liquidity problem or we're going to just see a series of rolling bubbles. That's no way to run an economy.


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