Fed chief acknowledges credit fears


Ben Bernanke acknowledged for the first time on Wednesday that credit concerns were spreading beyond the subprime mortgage market as investors showed their worries with a flight to quality, seeking refuge in government bonds and other safe assets.

Although Mr Bernanke played down the likely impact on the US economy, saying financial conditions remain generally favourable,” US Treasury yields fell sharply following the release of his testimony. At midday, 10-year notes were yielding a frac- tion less than 5 per cent, 5 basis points down on the day.

Investors were already shaken by the news that two Bear Stearns-managed hedge funds that had invested in subprime loans were nearly worthless.

Testifying before Congress, the Federal Reserve chairman said the US central bank was shaving back its central tendency” forecasts for growth this year and next, largely because of a more protracted drag from housing investment.

But there was no change to the Fed forecasts for inflation, underlining policymakers’ reluctance to put much store on a recent decline in core inflation.

Mr Bernanke emphasised the Fed remains focused on the risks to inflation rather than growth.

A weak spate of earnings reports added to the day’s gloom. On Wall Street, the S&P 500 index was 0.7 per cent lower at midday, following a day of losses across most of Asia and Europe.

The jitters also boosted S&P 500 volatility, as measured by the Chicago Board Options Exchange Vix index, which rose 7 per cent to 16.7.

Closely-watched derivative indices tracking corporate credit risk on both sides of the Atlantic rose across the board. The dollar weakened further against major currencies, with the New York Board of Trade dollar index falling to a 15-year low.

Mr Bernanke said conditions in the subprime mortgage sector have deteriorated significantly” and noted increased concerns among investors about credit risk on some other types of financial instruments.”

But he said even after their recent rise . . . credit spreads remain near the low end of their historical ranges” and added that business financing activity remained fairly brisk.”

The revised forecasts mean the Fed now thinks the economy will not return to close to its trend rate of growth until some time into next year.

Earlier on, policymakers had talked about a return to close to trend by the final quarters of this year.

Yet, Mr Bernanke appeared confident that both consumer spending and business investment would grow at a moderate pace” with some support from exports.

The Fed chairman said the problems in the housing market, aggravated by the subprime turmoil and higher mortgage rates, posed a downside risk to this growth outlook.

But he said there was also a risk that consumer spending could bounce back more strongly than expected.

While emphasising that core inflation is a better gauge of underlying inflation pressures than headline inflation, he said the Fed was mindful of the risks that high energy and food prices could be passed through to consumer prices or feed into inflation expectations. The jobs market also remained tight, he added.

Testifying before Congress, the Federal Reserve chairman said the US central bank was shaving back its central tendency” forecasts for growth this year and next, largely because of a more protracted drag from housing investment.

 


Financial Times
7/18/2007 2:43:56 PM