Is Bernanke Trying to Tell US Something About Interest Rates?

July 8, 2008

With stocks falling close to a 2 year low yesterday, Fed President Ben Bernanke attempted to stabilize the stock market and the US dollar by saying that they they are considering “extending the duration” of their emergency lending facilities to investment banks.

The Fed is clearly worried about the volatility in stocks and they have good reason to be because in as little as 2 months, the Dow has plunged 15 percent.

But more importantly, is Bernanke trying to tell us something about interest rates?

To extend the availability of emergency lending facilities means that there could still be liquidity problems in the financial markets. Keeping the lifeline open to banks and raising borrowing costs at the same time would actually be counterproductive, especially if they expect these banks to tap the lifeline. Bernanke is hinting to us that raising interest rates this year, even by 25bp is not a done deal.

Oil prices have fallen below $137 a barrel and if crude continues to drop, the Fed’s decision about interest rates will have been made for them. Bernanke and his colleagues are becoming extremely sensitive to market prices which could be very dangerous but for the time being it’s working.

The notion of the Fed being the lender of the last resort has helped US stocks and the US dollar recover.

Fed fund futures are currently pricing in a 45 percent chance that interest rates will be increased in September, down from a 65 percent chance a week ago. As for the October meeting, there is only a 53 percent chance that rates will be increased; the odds for December are about the same.

If the duration of the emergency lending facility is actually increased, then there is no way that the Fed will raise interest rates in 2008. But if yesterday’s volatility is not repeated and stocks bottom, then Bernanke’s comments today would be nothing more than an attempt to stabilize the equity markets.

Posted in Bernanke, FOMC, Fed rate hike, Federal Reserve, US Dollar, dollar rally