Misreading His Lips

The market rallied April 27 after investors misinterpreted Bernanke's remarks to Congress, thinking interest rate hikes would stop right away.
The market rallied April 27 after investors misinterpreted Bernanke's remarks to Congress, thinking interest rate hikes would stop right away. (By David Scull -- Bloomberg News)
By Nell Henderson
Washington Post Staff Writer
Wednesday, July 19, 2006

When Federal Reserve Chairman Ben S. Bernanke reports to Congress this week on the U.S. economic outlook, he will seek to explain his thinking more clearly to another important audience that has misunderstood him at times this year: the financial markets.

Stock and bond prices have swung widely in response to several of Bernanke's comments in recent months, as investors, traders and analysts have tried to figure out whether the new chairman was saying the Fed was nearly done raising interest rates or was going to keep hiking them to combat rising prices.

Bernanke's testimony to the Senate Banking Committee today and the House Financial Services Committee tomorrow offers an opportunity for him to explain to the markets how Fed policymakers view the economic slowdown, the recent rise in inflation and the uncertainty they face in adjusting interest rates, analysts and traders said this week.

"In terms of how Bernanke and the markets are communicating, I think they're sort of missing each other," said Sharon Lee Stark, a chief strategist at Stifel Nicolaus & Co., a brokerage in St. Louis. "This testimony will be important in reestablishing Fed communication with the markets."

Doing so is a top goal for Bernanke, a former professor and White House adviser who had stressed the importance of clear Fed communication long before he became chairman in February.

"He's a teacher. He learns what his students need to know," said Diane Swonk, chief economist at Mesirow Financial Holdings Inc., a private investment firm. "His weakness, coming in, is he wasn't a markets guy. . . . That's the disconnect."

One task for Bernanke today is to convince the markets that he will be tough on inflation while explaining that the Fed also needs to be flexible in responding to an economy in transition.

The economy grew rapidly from 2003 to 2005 but is slowing now in response to rising interest rates, higher energy costs and a softening housing market. Meanwhile, consumer inflation has moved higher in recent months as more companies have raised prices to cover their increased energy and raw materials costs.

The Fed seeks to promote economic expansion while keeping inflation low, and it does this by adjusting interest rates. When inflation is a concern, it raises borrowing costs to cool economic growth, which weakens businesses' power to raise prices.

Central bank policymakers have raised their benchmark short-term interest rate steadily for two years to keep inflation contained, moving it up in quarter-percentage-point steps at each of 17 consecutive meetings. It reached 5.25 percent last month.

Bernanke and his Fed colleagues believe the slowing economy will dampen price pressures, but they are not sure whether more interest-rate increases will be needed to keep inflation under control.

So they are no longer raising their benchmark interest rate automatically at every meeting. Instead, they are deciding what to do based on their ongoing analysis of the latest data on prices, growth and the labor market.

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