Bernanke's Bluntness Seems to Assure a Big Cut

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Weeks ahead of a key policy-setting meeting, Federal Reserve Chairman Ben Bernanke left little doubt the central bank will slash interest rates to bolster the sagging economy.

CHICAGO (Reuters) - Weeks ahead of a key policy-setting meeting, Federal Reserve Chairman Ben Bernanke on Thursday left little doubt the central bank will slash interest rates to bolster the sagging economy.

Speaking in Washington, Bernanke was unexpectedly blunt about the U.S. economy's worsening outlook, while adding that the Fed is "not currently" forecasting a recession.

He assured markets that the Fed stands ready to take "substantive additional action as needed" to support growth and would "act in a decisive and timely manner."

"Bernanke's comments will be regarded as unequivocally dovish," said Marc Chandler, senior currency strategist at Brown Brothers Harriman in New York.

So much for the poker face that some pundits had expected from Bernanke ahead of scheduled testimony on the economy to the House of Representatives Budget Committee next Thursday and with a series of key economic numbers set for release.

Traders responded decisively, as indicated by the short-term interest rate futures that measure market expectations on Fed policy.

The implied chances for a half-percentage point cut in benchmark overnight rates to 3.75 percent on January 29-30 hit 94 percent on Bernanke's comments, compared with 68 percent before the news broke.

The spread between U.S. two-year and 10-year Treasury notes yields rose to its highest since late 2004 as speculation of aggressive rate cuts ramped up.


"Bernanke is clearly giving up managing market expectations here, for he is apt to have further boxed the Fed into a 50 basis point move," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.

"Anything less will tend to disappoint the markets at this juncture," he said.

Bernanke's frank comments followed a chorus of recent assessments from economists that the United States is on the brink of, or perhaps has already in, a recession.

Haunted by the idea of a growth slowdown and falling earnings, the U.S. stock market has started 2008 in a gloomy mood -- although Bernanke provided some cheer.

In remarks at an event sponsored by two finance groups, Bernanke termed inflation expectations "reasonably well anchored."

Fed watchers interpreted the comment as a suggestion that inflation was only a small hurdle to clear in the way of bold interest rate cuts and seemed to play down the worry among some policy-makers that inflation could get out of hand.

"There are a lot of academics that believe they (the Fed) can't take their eye off the ball and let inflation grow above trend, but today is evidence they are willing to do that," said William Larkin, portfolio manager with Cabot Money Management in Salem, Massachusetts.

Interest rate futures rose the most in early-2008 contracts, suggesting the Fed's program of interest rate cuts could be focused on the first few policy-making meetings of the year.

Some pundits suggest the Fed wants to do all it can to stabilize the economy by mid-year and then stand aside months before the U.S. presidential election in November.

The implied federal funds rate by the end of June is near 3 percent, and by year-end is near 2.75 percent.

Bernanke termed "disappointing" a report last month that showed U.S. job creation at a near-standstill in December and the jobless rate rising rapidly. He warned that "should the labor market deteriorate, the risks to consumer spending would rise."

Consumer spending is the engine that powers economic growth in the United States, accounting for some two-thirds of the economy's thrust.

"In short, we have arrived at the point in the cycle where the Fed is becoming more worried about rising unemployment than the upside inflation risks," said Ian Shepherdson, chief U.S. economist at High Frequency Economics in Valhalla, New York.

(Additional reporting by John Parry in New York; Editing by Tom Hals)

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This article was originally published on 2008-01-10
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