Words are powerful and no one understands that more than Fed Chairman Ben Bernanke. Among those who follow the actions of the Federal Reserve, many believe that the Fed will hold rates steady at its meeting this week. All eyes will be scrutinizing the phrasing of the statement in order to uncover clues to any future rate increases. This type of semantic analyses can impact the confidence of the market over the short term.
The financial markets have become increasingly susceptible to any and all news as it relates to the Fed’s comments. The perception is that the Fed will attempt to strike a delicate balance between rising price pressures that would justify higher rates and a shaky economy that can’t take the additional pressure. While it holds the line on rates, it will not rule out that the prospect of a rate increase is imminent over the next few months. The challenge will be for the Fed to provide the environment for growth while recognizing that there are landmines that could derail a recovery.
Although there are signs of consumer strength with the increase in the GDP by 0.9% in the first quarter, the economy is still fragile. Recent economic data show continued weakness in the job market, with the jobless rate increasing 0.5 percentage points in May. At the same time, housing and manufacturing are still trying to overcome major challenges. Although the Fed will hold rates steady, it will need to emphasize the need for caution about inflation.
The Fed needs to address those competing needs of maintaining vigilance about inflation without stressing the markets. It is anticipated that Fed board members will probably describe economic conditions as weak or subdued as they have in the past, but also signal unprecedented comments that the risk of a severe downturn has receded.
On June 9 Chairman Bernanke signaled this in his remarks at the Federal Reserve Bank of Boston’s 53rd Annual Economic Conference when he said, “Indeed, although activity during the current quarter is likely to be weak, the risk that the economy has entered a substantial downturn appears to have diminished over the past month or so.”
It is expected that the Chairman will express the Fed’s concern about the potential for higher food and energy prices to boost inflation expectations. In its last two policy statements Fed officials referred to rising inflation expectations, which they hadn’t addressed in previous rate statements.
Officials likely will continue to forecast a moderation in inflation during the coming months as the slower economy eases pressure on labor and other resources. Overall inflation, as measured by the consumer price index, rose 0.6% in May; core prices that exclude food and energy rose a modest 0.2%.
In response to the latest round of energy price hikes and recent news about natural disasters impacting food costs, the Fed will be less likely to predict a leveling out of prices. The concern over oil prices in particular, will make any comment more difficult. This is the time for precision in words and in leadership to calm the markets.
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