Ben’s Blunt Words and a Warning Knock Markets Back

August 31, 2007, 10:07 am

Ben’s Blunt Words and a Warning Knock Markets Back

Posted by David Gaffen


Markets have pulled back from previous highs after the release of text from Ben Bernanke’s speech to economic types in Jackson Hole, Wyo. The chairman acknowledges the problems in subprime lending, why it took the actions it did, and reiterates its earlier stance about being ready to act in times of need.
But he warns “it is not the responsibility of the Federal Reserve–nor would it be appropriate–to protect lenders and investors from the consequences of their financial decisions,” and he also says that “the easing of some traditional institutional and regulatory frictions seems to have reduced the sensitivity of residential construction to monetary policy, so that housing is no longer so central to monetary transmission as it was.”
(Federal Reserve)

He does, however, say that consumer spending could be hurt by the housing downturn, saying “the increased liquidity of home equity may lead consumer spending to respond more than in past years to changes in the values of their homes; some evidence does suggest that the correlation of consumption and house prices is higher in countries, like the United States, that have more sophisticated mortgage markets.”
“We’ve got the impression that he’s very much of the view that not the Fed’s job to bail out financial markets when they get in trouble but should only respond to the economic outlook,” says Stephen Stanley, chief economist at RBS Greenwich Capital. “I think there’s a good chance they may go 25 in September, though I don’t think it’s a done deal.”
Federal-funds futures contracts were reducing odds on rate cuts. The November contract was lately trading with an implied yield of 4.73%, which implies a half-point cut, but only miniscule odds on a 0.75 percentage point cut by the end of October.
Yesterday, the November contract closed at a yield of 4.655%, betting on a half-point cut and a 38% chance of a 0.75 percentage point. The December contract’s implied yield was 4.615%, which, because the December meeting is on the 11th, the monthly average for the funds rate, should the Fed cut to 4.50%, would be 4.58%, so the current yield puts an 85% chance on a cut to 4.50%. Yesterday, the closing yield was 4.536%, which fully prices in a cut to 4.50% and even put low odds on a cut to 4.25%. (For a primer on figuring this out, see Real Time Economics.)
<LI>Stocks pulled back. The Dow Jones Industrial Average was up 85 points, compared with a 122-point gain just a few minute before the speech’s release. The S&P was up 11.3 points, compared with a 16.62-point gain.
<LI>Bonds were flat. The 10-year Treasury note was lately down 13/32, yielding 4.562%. Prior to the release the benchmark 10-year was down 14/32 to 4.568%.
The dollar was mixed. Against the yen the dollar was weaker, falling to 116.14, compared with 116.34 before the speech was released. The euro fell back to $1.3638, from $1.3670.


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