Fed Chairman Bernanke's Speech Highlights Downside Risks for Growth, Financal Markets

Published June 3rd, 2009 - 07:51 GMT

The US dollar and Japanese yen have bounced today due primarily to a resurgence in risk aversion, as highlighted by declines in global equities along with hefty losses in some of the classic FX carry trades like NZDJPY (-2.5%) and AUDJPY (-1.45%). This has been going for much of the morning, but a speech by Federal Reserve Chairman Ben Bernanke before the House Budget Committee certainly hasn't helped to boost confidence. Here is a summary of the speech text:

On Economic Developments and the Outlook...
While the US economy has contracted at an average annual rate of about 6 percent during Q4 2008 and Q1 2009, recent data suggests "that the pace of economic contraction may be slowing." Consumer spending has been "roughly flat since the turn of the year, and consumer sentiment has improved." Going forward, there will be two forces facing households, as "spending power will be boosted by the fiscal stimulus program," but at the same time, "the weak labor market, the declines in equity and housing wealth that households have experienced over the past two years, and still-tight credit conditions" will counteract.

Going forward, the Federal Reserve expects "overall economic activity to bottom out, and then to turn up later this year." However, even after recovery gets under way, "the rate of growth of real economic activity is likely to remain below its longer-run potential for a while, implying that the current slack in resource utilization will increase further." The central bank expected that "the recovery will only gradually gain momentum and that economic slack will diminish slowly. In particular, businesses are likely to be cautious about hiring, and the unemployment rate is likely to rise for a time, even after economic growth resumes." In light of this situation, the Federal Reserve also anticipates that inflation will remain low.

On Conditions in Financial Markets...
Bernanke said that conditions in a number of financial markets have improved since earlier this year, including short-term funding markets such as interbank lending markets and the commercial paper market. Longer-term credit markets have improved as well, as "bond issuance by nonfinancial firms has been relatively strong recently, and spreads between Treasury yields and rates paid by corporate borrowers have narrowed some, though they remain wide," while mortgage rates and spreads have "been reduced by the Federal Reserve's program of purchasing agency debt and agency mortgage-backed securities." Bernanke also noted, though, that "yields on longer-term Treasury securities and fixed-rate mortgages have risen" amidst "concerns about large federal deficits," but also cited "greater optimism about the economic outlook, a reversal of flight-to-quality flows, and technical factors related to the hedging of mortgage holdings" as potential causes.

On Fiscal Policy in the Current Economic and Financial Environment...
Bernanke again touched upon the widening federal budget deficit, which will hit "$1.8 trillion this fiscal year before declining to $1.3 trillion in 2010 and roughly $900 billion in 2011." According to Bernanke, this will ultimately bring the ratio of federal debt held by the public to nominal GDP from about 40 percent before the onset of the financial crisis to about 70 percent in 2011, the highest level since the early 1950s. As a result, he encouraged Congress, the Obama Administration, and the American people to confront spending issues, including Social Security and Medicare, highlighting that a crucial component was the setting of tax rates that "achieve an appropriate balance of spending and revenues in the long run."

On Federal Reserve Transparency...
Bernanke closed the speech by sayind that the Federal Reserve will son start publishing a monthly report on the tge central bank's balance sheet and lending programs that will "summarize and discuss recent developments and provide considerable new information concerning the number of borrowers at our various facilities, the concentration of borrowing, and the collateral pledged."

The full text of the speech can be found on the Federal Reserve's website.

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