Street Talk: How Far Will Bernanke Go?

What leading economists and market strategists are saying about the Fed's next moves

From Standard & Poor's Equity Research

What will Ben Bernanke & Co. do next in the face of a weakening economy and volatile financial markets? Here's a roundup of Jan. 11 comments from Wall Street economists and market strategists on their Federal Reserve policy expectations, as compiled by Standard & Poor's and BusinessWeek editors:

Ben States His Case

David Wyss, chief economist, Standard & Poor's

[In his Jan. 10 speech] Bernanke's worries about inflation were cited with uncharacteristic clarity: "[I]nflation expectations appear to have remained reasonably well-anchored, and pressures on resource utilization have diminished a bit." However, to make sure we didn't think that the Fed was getting too complacent, he also said that, "the increase in oil prices…is also lifting overall consumer prices and probably putting upward pressure on core inflation."

But the speech stressed the risk to growth much more than inflation. "The baseline outlook for real activity in 2008 has worsened and the downside risks to growth have become much more pronounced." The bottom line is that, "we stand ready to take substantive additional action as needed to support growth and provide adequate insurance against downside risks." Markets interpret this statement to mean that the Fed will start to cut rates more aggressively, beginning with a half-point cut in January. Another cut, perhaps another half-point, is likely at the March meeting and again in April. The federal funds rate seems likely to fall to 3% by midyear, rather than the 3.5% we had been assuming.

See More Fed Rate Cuts Ahead

Drew Matus, economist, Lehman Brothers

Bernanke's speech Thursday [Jan. 10] tipped the balance to a 50 basis point rate cut at the end of the month. Gone is the balanced risks talk and in its place is a clear focus on the downside risks to growth. This also confirms that the Fed will fight hard to avoid a recession and suggests that Bernanke is asserting a stronger public role in guiding market expectations. We now see the Fed funds rate reaching 3.00%, its terminal level for this cycle, by August. Bernanke's speech also suggested the credit crunch may be beginning to pinch consumers in areas other than mortgage finance, adding another headwind to energy prices, slowing job growth, falling home prices and an equity slump already buffeting the US consumer.

As he mentioned inflation only in passing and mostly emphasized why it should remain tame, we believe the Fed is squarely focused on growth for the time being. And, as a result, we now expect the Fed to cut rates by 50 basis points in January and deliver 25 basis points cuts in March, June and August.

Rate Cut Odds Increase

Tony Crescenzi, chief bond market strategist, Miller Tabak

Yesterday's [Jan. 10] poor chain store sales, an absence of data indicating the U.S. downturn has reached its trough, continued worrisome news from the nation's financial institutions, and the aggressive language used by Fed Chairman Ben Bernanke have combined to push rate cut odds sharply higher over the past two days. The market is for the first time priced for 100% odds that the Fed will lower the funds rate by 50 basis points by the Jan. 30 FOMC meeting, up from 88% odds yesterday, 76% odds on Wednesday [Jan. 9], and 66% odds a week ago. Two weeks ago the odds of a 50 basis point cut were zero.

Chatter about the chances at an inter-meeting cut or a cut as high as 75 basis points have actually pushed the odds of 75 basis points in cuts to 30% since early this morning. For the March 18 FOMC meeting, the market is priced for 100% odds of a cumulative 75 basis points in rate cuts and for 58% odds of 100 basis points in cuts (a 3.25% funds rate), up from 10% odds yesterday.

Fed Faces Economy, Inflation Dilemma

John Ryding, chief U.S. economist, Bear Stearns

The Fed continued to cut rates in December in response to the economic data -- lowering the [fed] funds rate to 4.25% -- and stepped up its actions against pressures in the funding markets with the introduction of the Term Auction Facility and the currency swap with the ECB and Swiss National Bank. On Thursday [Jan. 10], Fed Chairman Ben Bernanke raised the volume on his easing rhetoric saying that potential policy actions needed to be "substantive," "decisive," and "timely." The Fed appears to have significantly lowered its growth outlook again and reduced its inflation concerns.

We disagree with this latter assessment and the major casualties of Fed action continue to be the value of the dollar against gold, commodities, oil, and other currencies. Notably gold continues to hit record highs. Slowing growth and rising inflation provide a dilemma for the Fed and the Fed appears to be coming down strongly on the side of trying to support growth. We have changed our Fed call for the January FOMC meeting and now look for a half-point cut in the fed funds rate, to 3.75%.