World Looks to Bernanke to Clarify Plan06/17 07:23

   Is the era of ultra-low interest rates nearing an end? That's the question 
-- and the fear -- Chairman Ben Bernanke will face this week when he takes 
questions after a Federal Reserve policy meeting.


   WASHINGTON (AP) -- Is the era of ultra-low interest rates nearing an end?

   That's the question --- and the fear --- Chairman Ben Bernanke will face 
this week when he takes questions after a Federal Reserve policy meeting.

   Financial markets have been gyrating in the 3 weeks since Bernanke told 
Congress the Fed might scale back its effort to keep long-term rates at record 
lows within "the next few meetings"--- earlier than many had assumed.

   Bernanke cautioned that the Fed would slow its support only if it felt 
confident the job market would show sustained improvement. And earlier in the 
day, he said the Fed must take care not to prematurely reduce its stimulus for 
the still-subpar economy.

   Yet investors were left puzzled and spooked by a mixed message. Fear spread 
that the Fed would soon slow its $85 billion-a-month in bond purchases. Those 
purchases have been intended to hold down long-term borrowing rates to spur 
spending. Many worried that a pullback in the bond purchases could boost 
long-term rates, trigger a stock selloff and perhaps weaken the economy.

   On Wednesday, when the Fed ends a two-day policy meeting with a Bernanke 
news conference, the financial world will be looking to the chairman to settle 
the confusion. What, Bernanke will likely be asked, would show sustained 
improvement in the job market? And when will the Fed most likely slow the pace 
of its bond purchases?

   Last month, the U.S. economy added a solid 175,000 jobs. But the 
unemployment rate was 7.6 percent. Economists tend to regard the job market as 
healthy when unemployment is between 5 percent and 6 percent.

   Since Bernanke's vague public comments May 22, the Dow Jones industrial 
average has fluctuated sharply and shed about 3 percent of its value. But the 
bigger shock has been in the bond market. The rate on the benchmark 10-year 
Treasury has jumped from a low of 1.63 percent in early May to 2.13 percent.

   Higher rates ripple through the economy by making mortgages and other loans 
costlier. The average rate on the 30-year fixed mortgage, which tends to track 
the 10-year Treasury yield, reached 3.98 percent last week, according to 
Freddie Mac. That's its highest level since April 2012.

   Just as cheap mortgages have helped feed a housing recovery, higher rates 
might slow it. Refinancings have declined since Bernanke's comments led to 
higher mortgage rates: Refinancings are 36 percent below their recent peak at 
the start of May, according to the Mortgage Bankers Association.

   Compounding the confusion stirred by Bernanke's remarks have been comments 
from other members of the Fed's policy committee. Minutes of the previous 
meeting suggest a sharp division: Some, like Bernanke, still stress the need to 
fight high unemployment with low rates. Others warn that rates kept too low for 
too long raise the risk of high inflation and financial instability later.

   The Fed's investment purchases have swollen its portfolio to $3.4 trillion 
--- a four-fold increase since before the 2008 financial crisis. Eventually, 
the Fed will need to gradually sell its portfolio. Doing so would likely lead 
to higher rates. Yet some think it would also defuse some risks to the 
financial system.

   Alan Greenspan, who preceded Bernanke as Fed chairman for nearly two 
decades, said in a recent interview on CNBC, "The sooner we come to grips with 
this excessive level of assets on the balance sheet of the Federal Reserve --- 
that everybody agrees is excessive --- the better."

   Economists say Bernanke will seek to clarify the Fed's message Wednesday. 
Yet they're unsure what he'll say.

   Some think he could spell out the Fed's likely timetable for curtailing its 
bond purchases. The earliest the Fed is expected to announce a pullback is at 
its September meeting --- and only then if unemployment has declined and the 
economy is growing faster than its current sluggish annual pace of around 2 
percent.

   Other analysts think the economy will not have recovered enough by 
September. They believe the earliest the Fed will reduce its stimulus is at its 
final meeting of the year in December. Until then, they think Bernanke will 
seek to reassure investors that the Fed will make sure the economy has 
strengthened before it acts.

   "The Fed has worked very hard to get stock prices and home prices rising to 
help the economy, and I don't think they want to back away from that in any 
way," said Mark Zandi, chief economist at Moody's Analytics. "I think Bernanke 
will deliver a strong message that the Fed is not going to taper until the job 
market is improving in a consistent way."

   Some in this camp say the economy will continue to be held back by a Social 
Security tax increase that kicked in in January and by federal spending cuts 
that began taking effect March 1.

   "There is nothing in the underlying economy that would suggest the Fed needs 
to change policy any time soon," said Brian Bethune, an economics professor at 
Gordon College in Massachusetts. "There is considerably slower growth on the 
radar screen and absolutely no inflation to worry about."

   Indeed, the Fed's preferred gauge of inflation tied to consumer spending 
rose just 0.7 percent in the 12 months that ended in April--- far below the 
Fed's 2 percent target.

   Some think Bernanke will want to signal to investors on Wednesday that the 
Fed is moving toward at least the start of a reduced pace of bond purchases in 
the second half of the year. Sung Won Sohn, an economics professor at the 
Martin Smith School of Business at California State University, suggested one 
possible approach: The Fed could reduce its $85 billion a month in purchases to 
about $60 billion in September, then to about $35 billion early next year, then 
stop the purchases altogether by spring.

   Even when the Fed stops buying bonds, it's expected to maintain its current 
holdings, which would continue to exert downward pressure on long-term rates.

   Whatever guidance Bernanke offers Wednesday could help steady markets for a 
key reason: It will reduce uncertainty.

   Margie Patel, a portfolio manager at Wells Fargo Capital Management, thinks 
investors will remain calm even after the Fed slows its stimulus. She noted 
that the economy has been improving, however gradually.

   "There's no sector you can look at that's extremely dependent on the low 
rates for growth, even housing," she said. "If rates went up modestly, housing 
is still more affordable than it has been in years."


(KA)