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New US Fed chair Bernanke set for tough questioning

New Federal Reserve chairman Ben Bernanke will receive a likely baptism of fire in his first appearance before Congress this week amid conflicting views on the central bank's interest-rate policy.

Just two weeks after replacing Alan Greenspan at the helm of the powerful US central bank, Bernanke will deliver the Fed's semiannual monetary policy report to Congress and testify before the House Financial Services Committee today.

"Coming out of Greenspan's shadow is a difficult enough task for anyone. Currently for Bernanke, the burden of that task is complicated by the immediate economic situation," said Stephen Gallagher, an economist in New York for Societe Generale.

Proving his mettle

The Fed under Greenspan lifted key rates by a quarter-point 14 times as part of a move to normalize monetary policy after a long period of stimulating a weak economy.

But some analysts fear the Fed may go too far in its bid to nip inflation and could choke off economic growth. But Bernanke, who in a prior stint as a Fed governor was known more for his efforts to combat deflation, has to prove his mettle as an inflation-fighter, say experts.

"The inflationary implications drawn from the combination of exceptional growth and higher inflation could become more ominous when we incorporate the tightening labor market trends," Gallagher said.

"Our own view on inflation, and one shared by the market, is that inflationary pressures remain minimal," he said.

The bond market appears to be signaling an economic slowdown, with long-term rates for Treasury bonds lower than short-term rates. A further boost in Fed rates would exacerbate this "inversion" of the yield curve.

"Many are now becoming fixated upon the yield curve," said Kent Engelke, a market strategist at Anderson and Strudwick.

"As we have penned many times an inverted yield curve has a 100 percent correlation to a slowing economy and has preceded the last four recessions. We think the data suggests that there is little momentum going into the first quarter as the dual impact of higher oil prices and greater short-term interest rates are negatively affecting the economy," Engelke said.

Slowing growth

US economic growth slowed sharply in the fourth quarter of last year to a 1.1 percent annual pace, although some economists say this was due to one-time factors.

The Fed's preferred measure of "core" inflation was at 2.2 percent, slightly above what economists say is the "comfort zone" of the central bank. This makes the Fed's job of achieving a "soft landing" more delicate.

David Kotok at Cumberland Advisors said he believes Bernanke may give the markets a pleasant surprise of "clarity instead of Greenspanesque opacity."

Kotok said the economy appears to be "around trend growth" with only modest inflation pressures -- "not enough to trigger harsh Fed policy tightening."

"If Bernanke's testimony delivers the clarity and directness we expect, a great uncertainty will be lifted from the markets," Kotok said. "That is bullish for stocks since stock markets do not like uncertainty."

Kotok added that "bond markets will immediately adjust" to the outlook on inflation and growth from the new Fed chief.

"We think there is a slight upward bias coming to interest rates following Bernanke's testimony so we are continuing with a cautious view on bonds," Kotok added.

"It is hard to make a case for a bond rally without a serious slowdown in the US economy [but] Bernanke is not about to trigger a recession as a new Fed chairman if he can avoid it."
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