–Mon Policy Report Says S-Term Funding Mkts Stable, No Mention of IOER

By Joseph Plocek

WASHINGTON (MNI) – Federal Reserve Chairman Ben Bernanke’s monetary
policy testimony left two impressions: that the Fed is prepared to do
more in line with his dovish outlook, but that the timing and tools
remain up for discussion.

Bernanke reiterated the June FOMC decision that “made clear” the
Fed “is prepared to take further action as appropriate.” His usual list
of the tools remaining to the Fed — more asset purchases, sterilized or
not, altering guidance language, and lowering the interest rate paid on
excess reserves (currently 0.25%) — was absent, perhaps better left as
the an answer an inquiry.

Moreover, Bernanke did not mention the possible timing or trigger
for additional Fed action — he certainly did not mention presidential
elections or even the dates of the next FOMC meetings — presumably
leaving full flexibility to the FOMC, as is appropriate for the
chairman when presenting the opinion of his institution to Congress.

Bernanke described the U.S. as in recovery but in his opinion
“economic activity appears to have decelerated somewhat” in H1:2012. He
reviewed the already released Fed forecasts that call for modest growth
but reiterated there are higher risks and a higher degree of uncertainty
than normal.

The main risks are the European crisis and the U.S. fiscal cliff,
he said, noting there are “additional negative effects likely to result
from public uncertainty” that were not quantified.

In other words, Bernanke’s own opinion appears to be the economy
will slow further and that it’s the Fed’s job to foster “sustained
improvement” in the labor market. This outlook is bleaker than his words
in the February testimony, and his commitment more strongly worded.

But Bernanke left unanswered whether the “frustratingly slow”
improvement in unemployment is sufficient to spark ease, or indeed how
additional ease might bolster the demand needed to create jobs at a
faster pace.

If, as Bernanke described it, Operation Twist-2 was an ease that
encourages investors to acquire risk assets, how can the Fed keep this
pressure on? One unanswered controversy is whether short rates (a 25
basis point IOER and an approximately 18 basis point Fed funds rate)
have hit their floor.

The Monetary Policy Report’s section on short-term funding does not
discuss interest on reserves or possible money market fund problems if
short rates fall further. In fact, it calls funding markets “fairly
stable” in H1:2012.

Reasons that domestic money markets are better include reduced
funding by European banks and steady bid-asked spreads in repo
contracts. The Fed did note its sales of short Treasuries along with
increased T-bill issuance had raised dealer inventories and edged up
some short financing costs.

** MNI Washington Bureau: 202-371-2121 **

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