By Steven K. Beckner

DENVER (MNI) – Federal Reserve Chairman Ben Bernanke is wasting no
time talking about the economy and monetary policy in the new year.

Bernanke will be testifying before the Senate Budget Committee on
both monetary and fiscal policy Friday morning.

He will also have comments and likely take questions about fiscal
policy, but the main focus of financial markets will be what the Fed
chief has to say about the recent improvement in consumer spending,
manufacturing and other facets of economic activity and what that
implies for monetary policy.

Bernanke’s testimony will be particularly timely, coming in the
aftermath of the Labor Department’s December employment report, which is
expected to show a bulge in non-farm payrolls.

In particular, lawmakers and outside observers will want to know
how he sees the outlook for economic growth, employment and inflation
and, on that basis, how much further stimulus he thinks the central bank
needs to provide.

Later Friday, Chicago Federal Bank President Charles Evans, a
voting member of the Fed’s policymaking Federal Open Market Committee,
will speak about the future of monetary policy at the annual meeting of
the American Economic Association and the Allied Social Science
Associations here in the Mile High City. Boston Fed President Eric
Rosengren will speak at the convention as well.

Saturday, Fed Vice Chairman Janet Yellen will give her views on the
Fed’s asset purchase program — popularly known as “QE2.”

The FOMC launched its second round of quantitative easing — $600
billion of longer term Treasury securities purchases by the end of the
second quarter — on Nov. 3 with mixed results.

Although the Fed’s intent was to lower longer term interest rates
and to spur some portfolio shifting into riskier assets, principally
stocks, yields have risen sharply.

It’s a matter of dispute how much of the yield spike is due to
market disappointment that the FOMC didn’t authorize even larger asset
purchases; how much is due to stronger growth and hence stronger
prospective demand for capital that was in train before QE2; how much is
due to budget deficits fears, and how much is due to rising inflation

Bernanke is sure to give his own assessment of the various factors
and influences.

Critics of QE2 have maintained that higher rates show the futility
of the program, but that’s not the way it is seen at the Fed, judging
from minutes of the Dec. 14 FOMC meeting.

“The decision to expand its holdings of longer-term securities by
$600 billion by the end of the second quarter of 2011 was … roughly in
line with market expectations, although market participants appeared to
expect the purchase program would be increased over time,” the minutes
state in summarizing the Fed staff view.

“In the weeks following the November meeting, yields on nominal
Treasury securities increased significantly, as investors reportedly
revised down their estimates of the ultimate size of the FOMC’s new
asset-purchase program,” the minutes continue. “Incoming economic data
that were viewed, on balance, as favorable to the outlook and news of a
tentative agreement between the Administration and some members of the
Congress regarding a package of fiscal measures also reportedly
contributed to the backup in yields. Market participants pointed to
abrupt changes in investor positions, the effects of the approaching
year-end on market liquidity, and hedging flows associated with
investors’ holdings of MBS as factors that may have amplified the rise
in yields.”

As for how FOMC members and other participants saw the post QE2
yield upsurge, the minutes record that they “pointed to a number of
factors that appeared to have contributed to the significant backup in
yields, including an apparent downward reassessment by investors of the
likely ultimate size of the Federal Reserve’s asset-purchase program,
economic data that were seen as suggesting an improved economic outlook,
and the announcement of a package of fiscal measures that was expected
to bolster economic growth and increase the deficit over coming

“It was noted that the backup in rates may have been amplified by
year-end positioning, as well as by some reported mortgage-related
hedging flows,” the minutes go on. “A number of participants indicated
that, because the backup in rates appeared to importantly reflect
changes in investors’ expectations about the size of Federal Reserve
asset purchases, the backup was consistent with purchases helping to
keep longer-term yields lower than would otherwise be the case.”

Left unanswered and available for Bernanke’s response are such
questions as:

– how will the rise in market interest rates, not to mention oil,
food and other commodity prices affect the recovery?

– will the rise in rates lead the Fed to do even more QE?

– or will the improvement in the economy and rise in inflation
expectations inspire the FOMC at some point to terminate or scale back

Getting the jump on Bernanke and other Fed officials on Wednesday,
Kansas City Federal Reserve Bank President Thomas Hoenig surprised no
one when he made clear that he thinks the Fed is already going too far
with monetary stimulus.

After saying he is “increasingly confident that the recovery is
both sustainable and likely to gain strength over the next several
quarters,” Hoenig warned that continuing to hold rates down and pumping
hundreds of billions of dollars of newly created money into the system
invites higher inflation and other problems.

“In essence, the Federal Open Market Committee (FOMC) has
maintained an emergency monetary policy stance in a recovering economy
and has continued to ease into the recovery,” he said. “I believe these
actions risk creating a new set of imbalances, or bubbles. Importantly,
such actions as they continue are demanding the saving public and those
on fixed incomes subsidize the borrowing public.”

Hoenig advocated a “slow” and “careful” exit from the Fed’s
expansionary, zero interest rate policy.

But upcoming comments from Bernanke, Evans and Yellen are apt to
show that Hoenig remains in the minority, although he is likely to have
sympathy from incoming FOMC voters Richard Fisher and Charles Plosser,
heads of the Dallas and Philadelphia Federal Reserve Banks.

They both speak next week, as does Minneapolis Fed President
Narayana Kocherlakota, who has supported QE2, albeit with some degree of

** Market News International **

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