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Fed

Chairman Ben Bernanke sounded characteristically hawkish in his speechbefore the Italian American Foundation moments ago, continuing a strategybegun in earnest in September when Fed Vice Chairman Don Kohn signaled tothe markets that its expectation for a near-term interest rate cut waswrongheaded.

Bernanke's speech today was airtight, with the chairmanleaving virtually no room for investors to conclude that the Fed iscontemplating an interest rate cut. Ostensibly, the Fed's strategy is tolock in gains that it has made on inflation and inflation expectations. TheFed is taking no chances.

Bernanke's comments are consistent with what the markets are already pricedfor; chiefly, that the Fed will not act on interest rates for six months.Moreover, with the inflation rate falling, the real fed funds rate (the fedfunds rate minus inflation) is rising, meaning that Fed policy is gettingtighter.

The markets are priced for this tightening of policy via theinverted yield curve, the inverted spread between Treasuries and the fedfunds rate, and the TIPS market.

Many are perplexed as to why it is that the Fed has left so little room forspeculation about an interest rate cut despite both the slowing in theeconomy and the lowering of the inflation rate and inflation expectations.

Again, the main reason seems to be that the Fed wants to guard the gainsthat it has made on the inflation front and gain credibility for thepromulgation of the Bernanke era. In addition, the Fed need not signal an interest rate cut. Rate cuts are"good" news and needn't be signaled in the same way as interest rate hikesmust be. The Fed can deliver its cuts either by surprise or on shortnotice.

Moreover, if the Fed were to signal its interest rate cuts toosoon, financial conditions would loosen perhaps too much, too soon. Stockprices would rise, bond yields would fall, the dollar would fall, creditspreads would tighten, and bank lending standards would loosen.

All ofthese conditions would be conducive to stronger growth, something that theeconomy does not yet need because a small buildup of economic slack isneeded to fully wring inflation from the system.

Tony Crescenzi is the chief bond market strategist at Miller Tabak + Co., LLC, and advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. At the request of the Federal Reserve, Crescenzi is a regular participant in the board's Livingston Survey of economic forecasters. He is also the author of

The Strategic Bond Investor

. At the time of publication, Crescenzi or Miller Tabak had no positions in the securities mentioned in this column, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Crescenzi also is the founder of Bondtalk.com, a popular Web site covering the bond market and the economy. Crescenzi appreciates your feedback;

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