The Trio Testifies

Today’s Congressional testimony by Fed Chairman Bernanke, Treasury Secretary Paulson, and SEC Chairman Cox was the first time the heads of those three agencies appeared together since September 2001. Exactly what the appearance of this economic junta was supposed to communicate to the markets is not entirely clear. Bernanke seemed to take a somewhat less urgent tone than he has lately, but he left no doubt that further interest rate cuts are coming. The futures markets indicate the Fed Funds rate will drop to 2% by June. 
Faced with rapidly deteriorating economic indicators, Bernanke is lowering short-term rates because there is not much more he can do. He is fully aware that it is not having the desired effect, saying today “More-expensive and less-available credit seems likely to continue to be a source of restraint on economic growth.” Translation: “If you want to borrow money, forget about it.” Of course, if the Fed were holding rates steady the economy might be even worse off. But the sad fact is that neither the Fed nor the government have the ability to bail us out.

 
The downside to lower interest rates is that the result is often inflation. This is why long-term interest rates are trending up as short-term rates move down. Other consequences are a falling dollar and rising commodity prices. Energy and materials continue to be among the strongest equity sectors. In theory, a weak U.S. economy should be bearish for oil prices, yet they remain stubbornly high. Why? One clue may be today’s report of sharply higher than expected economic growth in Japan. Analysts have long anticipated a day when the U.S. no longer leads the rest of the world’s economies.

That day may be drawing closer.