Fed Officials Watch Asset Prices for Signs of ‘Excessive Risk’

By Craig Torres

Nov. 25 (Bloomberg) -- Federal Reserve policy makers said for the first time that their decision to cut interest rates to zero may be fueling undue financial-market speculation even as they called the dollar’s decline “orderly.”

The Federal Open Market Committee said its policy of keeping rates low might cause “excessive risk-taking” or an “unanchoring of inflation expectations,” according to minutes of its Nov. 3-4 meeting released yesterday. Central bankers also said further dollar depreciation that might “put significant upward pressure on inflation would bear close watching.”

The dollar weakened as investors wagered the central bank will tolerate further declines in a currency that has slid more than 6 percent against the yen in three months. Policy makers are wary of fueling a third asset-price bubble in about a decade as they hold the benchmark interest rate near a record low to revive growth, economists said.

“Financial markets have been doing much better than people might have expected,” said Marvin Goodfriend, a former policy adviser at the Richmond Fed who is now a professor at Carnegie Mellon University in Pittsburgh. “The Fed is saying to markets, ‘Don’t overdo it.’”

Fed Chairman Ben S. Bernanke, 55, will face lawmakers’ scrutiny when he appears on Dec. 3 before the Senate Banking Committee for a hearing on his nomination to a second term.

Senator Christopher Dodd, the committee’s chairman and a Connecticut Democrat, has blamed the Fed for lax supervision that led to a credit-fueled housing bubble. The bust in home prices, along with borrower defaults, led to the worst recession since the Great Depression.

Fuel Speculation

Last week, policy makers in China and Japan said low U.S. interest rates are fueling surging prices of commodities as well as financial assets in emerging markets.

The decline of the dollar and decisions in the U.S. not to raise interest rates have caused “huge” speculation in foreign exchange trading and global asset prices, Liu Mingkang, chairman of the China Banking Regulatory Commission, said Nov. 15.

Gold prices touched an all-time high of $1,174 an ounce in New York on Nov. 23 as a slumping dollar boosted the appeal of alternative assets. The Standard & Poor’s 500 index has jumped 63 percent since its 2009 low on March 9, and the MSCI AC World stock index is up 72 percent.

The dollar weakened to the lowest level versus the yen in a month after the minutes were released yesterday. The dollar fell 0.5 percent in New York to 88.55 yen at 4:33 p.m. in New York from 88.97 on Nov. 23, after touching 88.36, the lowest level since Oct. 9.

Excessive Risk Taking

Fed policy makers at their meeting this month repeated their commitment to keep the benchmark interest rate “exceptionally low” for an “extended period.” In their discussion of asset prices, they said the likelihood of excessive risk-taking was “relatively low.”

Even so, officials “introduced topics that they traditionally avoid,” said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Asset values “can be considered some of the additional factors that would influence their outlook for inflation and growth.”

The U.S. economy grew less than initially estimated last quarter as consumer spending trailed forecasts, according to a Commerce Department report released yesterday. The economy expanded at a 2.8 percent annual rate, less than the initial estimate of a 3.5 percent pace of expansion.

‘Balanced’ Risks

“Most participants now viewed the risks to their growth forecasts as being roughly balanced rather than tilted to the downside, but uncertainty surrounding these forecasts was still viewed as quite elevated,” the minutes said. Among the risks policy makers considered was a jobless recovery.

“Most members projected that over the next couple of years, the unemployment rate would remain quite elevated and the level of inflation would remain below rates consistent over the longer run with the Federal Reserve’s objectives,” the minutes said.

Fed officials trimmed their forecasts for the U.S. jobless rate in 2010 and 2011, the minutes showed. Fed governors and regional bank presidents predicted the rate will range from 9.3 percent to 9.7 percent in next year’s fourth quarter, down from their June projection of 9.5 percent to 9.8 percent.

The U.S. economy has lost 7.3 million jobs since the recession began in December 2007. The unemployment rate rose last month to a 26-year high of 10.2 percent. U.S. payrolls shrank by 190,000 jobs last month, and the average workweek held at a record low.

AOL, the Internet unit being spun off from Time Warner Inc., plans to cut as much as 2,300 staff, or about one third of its workforce, over the next several months. Aetna Inc., the third-largest U.S. health insurer, said Nov. 18 it’s cutting about 625 positions and plans to eliminate a similar amount next year to cope with the recession and the potential effects of the U.S. health overhaul.

To contact the reporters on this story: Craig Torres in Washington at ctorres3@bloomberg.net