By Craig Torres
Sept. 16 (Bloomberg) -- Federal Reserve Chairman Ben S. Bernanke, who yesterday said the U.S. recession probably has ended, may have to accept a slow recovery and high unemployment as the price for defending his inflation-fighting credentials.
“Even though from a technical perspective the recession is very likely over at this point, it’s still going to feel like a very weak economy for some time,” Bernanke said in response to questions after a speech at the Brookings Institution in Washington. “That’s a challenge for us and all policy makers going forward.”
Policy makers predicted in June that the unemployment rate will remain above 9 percent through the end of next year, while inflation will stay below their preferred range. That hasn’t stopped them from starting to unwind their extraordinary monetary stimulus as investors express concern that the expansion of the Fed’s balance sheet to $2.1 trillion will ignite inflation when the economy recovers.
“The Fed is in an odd situation here,” said Michael Feroli, an economist at JPMorgan Chase & Co. in New York. “Both aspects of their dual mandate for growth and inflation will have suboptimal outcomes, but they can’t do anything to speed things up because of concerns about inflation credibility.”
The Federal Open Market Committee may extend the end-date of its $1.45 trillion program to buy housing-agency and mortgage-backed securities at its next meeting Sept. 22-23. There is little chance that it will expand the program after deciding in August to end purchases of $300 billion in Treasury debt next month.
Greenspan ‘Worried’
Former Federal Reserve Chairman Alan Greenspan said he’s worried that lawmakers will hamper U.S. central bank efforts to rein in its monetary stimulus, and that inflation might “swamp” the bond market.
“It’s the politics in the United States that worries me, whether the Congress will basically feel comfortable” with the Fed withdrawing its stimulus, Greenspan said from Washington in a broadcast to Tokyo clients of Deutsche Bank Securities Inc. today. He later said that “if inflation rears its head, it will swamp long-term markets,” referring to bonds.
Central bankers have pledged to keep the benchmark lending rate in a range of zero to 0.25 percent “for an extended period.” If unemployment lingers at high levels, officials could face questions on whether they have done enough to push the economy to a faster rate of growth, economists say.
“At the end of 2010, the story may not be whether they exited correctly, but how did they allow this outcome to occur,” said Laurence Meyer, a former Fed governor and vice chairman of Macroeconomic Advisers LLC. in Washington. “The definitive marker of the end of easing was the decision at the August FOMC meeting to allow Treasury purchases to expire.”
‘Moderate Growth’
The FOMC’s June forecasts show unemployment above 8 percent in the final three months of 2011. A majority of FOMC members also forecast inflation will be below their long-run preferred range of 1.7 to 2 percent next year, Fed minutes show.
“If we do in fact see moderate growth, but not growth much more than the underlying potential growth rate, then unfortunately unemployment will be slow to come down,” Bernanke said yesterday, noting that the economy faces “headwinds” such as tight credit. “It will come down, but it will take some time.”
At the same time, the Fed could startle markets if it decided to buy up more government debt, expanding the balance sheet even further. Gold futures reached an 18-month high of $1,013.70 an ounce on Sept. 11 as the U.S. Dollar Index, which values the greenback against six other currencies, dropped to its lowest level in almost a year.
Inflation Concern
“Those buying gold believe the Fed is going to be accepting inflation if not even promoting it,” said Axel Merk, whose $370 million Hard Currency Fund is up 11.3 percent year to date on investments in precious metals and foreign currencies.
Yields on the 10-year Treasury note rose for a second day yesterday after a report from the Commerce Department showed that retail sales surged in August by the most in three years, adding to evidence the economy is recovering. The yield on the 10-year note rose to 3.46 percent at 5:32 p.m. in New York from 3.42 percent the day before.
The difference between rates on 10-year notes and Treasury Inflation Protected Securities, or TIPS, which reflects the outlook among traders for consumer prices, widened to 1.84 percentage points from 1.66 percentage points two weeks ago. It has averaged 2.19 percentage points over the past five years.
Underscoring the Fed’s view that inflation will be contained, a Labor Department report today showed that consumer prices fell 1.5 percent in August from the previous year. Prices rose 0.4 percent in August from a month before, following no change in July.
Bank Reserves
Regional Fed bank presidents Jeffrey Lacker, of Richmond, and James Bullard, of St. Louis, have said the central bank may not even need to complete its purchases of $1.45 trillion in mortgage-backed and housing-agency securities.
“With the economy leveling out and beginning to grow again later this year, and with bank reserve demand ebbing as financial conditions improve, I will be evaluating carefully whether we need or want the additional stimulus,” Lacker said Aug. 28 in a speech in Danville, Virginia.
His concern is that the Fed will so over-supply demand for bank reserves that it will suppress money-market rates even when the central bank is trying to raise them.
That increase could come as soon as “the first part of next year” if inflation picks up, Stanford University economist John Taylor told Bloomberg Television last week.
Credit Risk
The risk is that credit conditions remain tight, consumers keep a lid on spending, and the expansion never gets to a rate that will cause employers to hire, say economists including Richard Berner, co-head of global economics at Morgan Stanley in New York.
“While markets have improved and the cost of credit has declined dramatically, the capacity and willingness to lend are still somewhat impaired,” said Berner, a former researcher at the Fed. “That restraint is the key reason why we expect a moderate, rather than a V-shaped recovery.”
David Simon, chairman and chief executive of Simon Property Group Inc., the largest U.S. shopping mall owner, said “It’s too early for us to declare the recession over.”
“Ultimately, what’s important to retail and real estate is the health of the consumer, the job outlook and so on,” Simon said in an interview, when asked to respond to Bernanke’s comments on the recession. “I still think the consumer’s under pressure.”
To contact the reporter on this story: Craig Torres in Washington at ctorres3@bloomberg.net; Scott Lanman in Washington at slanman@bloomberg.net.
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