Some on Wall Street think Ben Bernanke has a communication problem. They say he gives mixed messages about the economy and about the Federal Reserve's intentions, leaving investors confused.
But they're missing the point -- the recent economic data isn't so clear cut either. And consider the alternative if he becomes tightlipped: There won't be any clues about where interest rates could go next.
There is no doubt that Bernanke has gotten off to a bumpy start since taking the Fed's helm on Feb. 1 from the retiring Alan Greenspan. As some economists have put it, he is a rookie making rookie mistakes.
PHOTO: EPA
Much of that comes from what was expected from Bernanke, and how he has delivered.
While Greenspan was known for being evasive and often difficult to decipher, he and other Fed policymakers did significantly increase what they would discuss publicly during the latter half of his 18 years of leadership.
Bernanke, in turn, has long advocated transparency in the Fed's communication to improve signals about whether central bankers are leaning toward increasing, reducing or leaving borrowing costs unchanged. Lately, all the action has been to the upside: The Fed has boosted the overnight bank lending rate to 5 percent in 16 quarter-point steps since June 2004 to slow the economy and keep inflation in check. Its policymaking panel next meets on Wednesday and Thursday.
Upon Bernanke's arrival at the Fed, financial markets welcomed the idea of a plain-speaking, straight-shooter. But now they are thinking they've gotten more than they asked for.
It all started on April 27, when Bernanke testified before Congress that "at some point in the future, the committee may decide to take no action at one or more meetings.
Investors' translation: The Fed may stop raising rates at this week's meeting.
Stocks rallied, but the gains didn't last for long. The following Monday, financial markets were hit hard when reporter Maria Bartiromo disclosed that the Fed chairman told her the previous Saturday that his congressional testimony had been misunderstood.
The flip-flopping didn't stop there. The Fed issued a statement on May 10 saying that "inflation expectations remain contained." But many investors disagreed, especially after April's core inflation reading released on May 17 showed that prices accelerated to a brisk 3 percent annual rate even after higher food and energy costs were excluded. Then on May 24, Bernanke said that inflation expectations were "well contained," which market participants viewed as dovish.
On June 5, Bernanke seemed to have changed his tune again when he talked publicly in a speech about the danger of rising inflation. The result was ugly: Stocks plunged on the news, with the Dow Jones industrial average losing almost 250 points in two days.
Then a few days later, stocks rose sharply after Bernanke said record energy and commodity prices could account for some of the recent uptick in core prices but that inflation expectations have remained within historical ranges.
"Ben Bernanke is trying to improve Fed transparency by being more plainspoken than former Fed chairman Greenspan," said Morgan Stanley economist Richard Berner. "But even the most finely crafted and straightforward language can leave room for misinterpretation."
Maybe market-players should consider what Bernanke is up against: A cloudy economic picture with what looks to be slowing growth and rising inflationary pressures. Usually, the Fed raises interest rates to tame inflation, but we've reached a point where policy-makers have to avoid tipping the economy into a recession by boosting rates too much.
It isn't an easy fix, and the way he's been talking "reflects the true uncertainty about the future course of the economy and policy, and thus the increasingly complicated policy choices the Fed faces," said Lehman Brothers' chief US economist Ethan Harris. "It is hard to sound transparent when the message is `we don't know.'"
Still, Bernanke could use some fine-tuning in his execution, and he knows it. He has tapped vice chairman designate Donald Kohn to study how the Fed communicates with financial markets.
Investors, at the same time, could use a little patience. Beating up Bernanke seems like the thing to do right now because he isn't saying what they want to hear and they hate his delivery. But it is going to take time for him to better hone his message and for markets to understand his way of speaking.
Now, Bernanke faces a key decision on interest rates this week.
Financial markets widely expect the policymaking Federal Open Market Committee (FOMC), which holds a two-day meeting on Wednesday and Thursday, will boost its base rate another quarter-point to 5.25 percent, in a 17th consecutive hike.
More important, however, is the tone of the FOMC statement, which will try to prepare the markets for upcoming actions and signal how far it intends to lift rates to hold inflation in the face of jittery investors who fear the central bank may go too far in cooling growth.
Harris said he sees Bernanke signaling a tough stand on inflation.
"We expect a hawkish FOMC directive," Harris said.
"We look for a statement that attempts to affirm the Fed's inflation-fighting credentials, but also emphasizes flexibility," he said.
Harris said the Fed believes it must keep inflation from taking root even if it means cooling or halting economic growth. He now predicts the Fed will lift the base rate to 5.75 percent this year before halting.
Lewis Alexander, chief economist at Citigroup, said fears are exaggerated about inflation as well as the dreaded possibility of "stagflation," which refers to economic stagnation in an inflationary environment. He sees the Fed halting its rate-hike cycle at 5.5 percent in August.
"What you're seeing is a normal cycle as opposed to something more adverse," Alexander said.
"We think the Fed will raise rates two times -- now and in August -- before pausing. We think it will be clear then that the economy will be slowing and that will contain some of the inflation we are seeing," he said.
Yet there remains a heated dispute among economists, some who believe the Fed may have to hike rates as high as 6 percent, and others who believe the central bank may already have gone too far.
The economic data so far have been confusing. The US economy expanded at a 5.3 percent pace in the first quarter, but many believe a sharp slowdown is underway.
"A drop in industrial production is not consistent with a strong economy," said Donald Ratajczak, consulting economist for Morgan Keegan. "When you add further that the 200,000 drop in housing starts has not yet impacted construction employment, yet employment is already growing below sustainable trend, then the stagflation fears are very real."
Ratajczak said he believes the FOMC will lift rates to 5.5 percent but will "reverse direction once growth slows below 2.0 percent, as I now assume in early 2007."
Berner said a long period of low rates has provided a false sense of security about inflation.
"It is beguiling to think that globalization will contain US inflation and that the recent acceleration in consumer prices will quickly dissipate on its own. I disagree," he said.
On the other side of the spectrum, economist Benjamin Tal at CIBC World Markets said Bernanke and the Fed must understand that inflation is "a lagging indicator," and need to look forward to avert a mistake.
However, "it takes nerves of steel to stop hiking rates in the face of accelerating inflation," Tal said.
"We are still working on breaking the Bernanke Code, but it is clear by now that he is ready and willing to overshoot in the short term," he said.
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