Ben Bernanke, chairman of the Federal Reserve, testified before the Senate Banking Committee today and while the testimony was typically opaque, the results were easily observed. Ten Year Treasury note yields fell by 7 basis points and the stock market rallied smartly, with the Dow up 212 points.
Bernanke's prepared remarks can be found here.
Here are a few highlights and my interpretation of what he really meant:
"Over the period since our February report, the U.S. economy has continued to expand. Real gross domestic product (GDP) is estimated to have risen at an annual rate of 5.6 percent in the first quarter of 2006. The available indicators suggest that economic growth has more recently moderated from that quite strong pace, reflecting a gradual cooling of the housing market and other factors that I will discuss. With respect to the labor market, more than 850,000 jobs were added, on net, to nonfarm payrolls over the first six months of the year, though these gains came at a slower pace in the second quarter than in the first. Last month the unemployment rate stood at 4.6 percent."
The economy was smoking in the first quarter, but it's starting to slow down. Housing is slowing but I don't think it's falling off a cliff. We're adding just enough jobs to keep the unemployment rate steady.
"Inflation has been higher than we had anticipated in February, partly as a result of further sharp increases in the prices of energy and other commodities."
Inflation is too darn high because the Fed has printed too many greenbacks, but I can't say that out loud, so I'm going to blame it on higher energy prices.
"The U.S. economy appears to be in a period of transition."
The economy is slowing down and I have no clue how much.
"...moderation appears most evident in the household sector. In particular, consumer spending, which makes up more than two-thirds of aggregate spending, grew rapidly during the first quarter but decelerated during the spring. One likely source of this deceleration was higher energy prices, which have adversely affected the purchasing power of households and weighed on consumer attitudes."
When filling up the SUV requires a mortgage application, folks don't have as much to spend down at Walmart.
"The slowing of the housing market may restrain other forms of household spending as well."
When Joe Sixpack can't refinance his mortgage anymore and has to actually start paying off that debt, he won't be buying a new car.
"Although growth in household spending has slowed, other sectors of the economy retain considerable momentum. Business investment in new capital goods appears to have risen briskly, on net, so far this year."
I hope business spending holds up because if not, we're headed for recession.
"Globally, output growth appears strong. Growth of the global economy will help support U.S. economic activity by continuing to stimulate demand for our exports of goods and services. One downside of the strength of the global economy, however, is that it has led to significant increases in the demand for crude oil and other primary commodities over the past few years. Together with heightened geopolitical uncertainties and the limited ability of suppliers to expand capacity in the short run, these rising demands have resulted in sharp rises in the prices at which those goods are traded internationally, which in turn has put upward pressure on costs and prices in the United States."
I can't blame the Fed for the rise in commodity prices, so I'm going to blame China.
Alright, enough Bernanke bashing. As many of you know, I'm not a fan of Mr. Bernanke or the Federal Reserve in general. I've listened to a lot of these semi annual reports to Congress and they rarely break news. This time though with Bernanke being so new, it did seem to give a little peek into his thinking about monetary policy. In my opinion there were several important clues in the testimony:
1. He emphasized the lagging effect of monetary policy. He even blunted this mornings CPI reading by saying that the Fed can't do anything about currently reported inflation but must look forward to the results of past monetary policy changes.
2. The Fed believes the economy is slowing to a rate closer to potential which they peg at somewhere around 3-3.5% growth.
3. The Fed believes that core inflation will fall to 2 1/4-2 1/2% this year (from the currnet 2.5%) and even further to 2-2 1/4% in 2007.
The market heard all this and decided that it means the Fed will be pausing on the rate hikes sometime soon. I think they will too, but I'm at least a little worried that they've already gone too far. The housing market is rolling over pretty hard in some areas and that could have a drastic effect on employment. Many of the jobs created over the last four years were related to real estate and a real estate crash would have far reaching consequences. Hopefully a pause by the Fed will stablize the market and limit the damage. We'll see.