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Fed Chairman Testified to the U.S. Senate Today14 Feb 08The Federal Reserve remains concerned about downside risks to U.S. economic growth and keeps the door open for further interest rate cuts. Ben Bernanke delivered a surprisingly short prepared testimony to the Senate Banking Committee today. What came out loud and clear, though, is that the Fed has become increasingly concerned about mounting stresses in the financial system—stresses that have led to substantially more expensive and substantially less available credit—combined with increased downside risks to growth, stemming from weaker payroll employment and further deterioration in the housing market. These heightened concerns about the short-term outlook are partially offset by the expectation that exports should continue to grow, while the recently approved fiscal-stimulus package should help to support spending in the second half of this year. The critical task for the Fed, as aptly articulated by Bernanke, is to assess whether the stance of monetary policy is properly calibrated, given the variable lags of monetary policy, the medium-term forecasts for economic activity and inflation, and the downside risks to growth. For now, the Fed sees sluggish growth in the first half of 2008, followed by a stronger second half. Global Insight is projecting that the downside risks to growth will become more apparent as the first quarter progresses. Activity in the services sector is contracting, and consumer spending is running further out of steam. Payroll employment growth is expected to stall in the first quarter, while the huge drag from the deteriorating housing market will become more apparent in upcoming reports on real growth—which will point toward a "mild" recession in the first half of 2008. Therefore, the economy's short-term prospects are not as rosy as the "sluggish growth" outlook offered by Bernanke. In the light of this, we are forecasting that the Fed will reduce interest rates by a further 50 basis points on March 18 and another 50 basis points on April 30. Those actions will take the federal funds rate down to 2.00%, where we expect the Fed to hold them for the duration of 2008. by Brian Bethune
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