Did Bernanke’s Speech Inspire a Sell-Off?

Perhaps unsurprisingly, Federal Reserve Chairman Ben Bernanke failed to inspire confidence in the markets when he delivered a speech at the New York Economic Club on Tuesday afternoon. U.S. equity markets moved lower after Bernanke painted a picture of the economy where the rate of inflation was the only thing under control.

Over the last three years consumer price inflation “has averaged almost exactly 2 percent, which is the FOMC’s longer-run objective,” he said early on. Long-term expectations remain stable despite fluctuation in commodity prices. Bernanke continues on to give a run down of the current economic state: high unemployment that is only slowly declining, just over 2 percent GDP growth since the crisis, and headwinds from the credit crisis and housing bubble.

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Despite recent economic indicators suggesting a slow but steady recovery in the housing market, Bernanke points out that past financial crises associated with housing booms and busts have been associated with “many years of subsequent weak performance.” Specifically, the potential rate of growth in the affected economy will be reduced. He seems to conclude that the 2 percent growth seen recently may be exactly what should be expected, and that the 2.5 percent and higher clip seen before the recession may be a few years away.

The Catch-22 is that this rate of economic growth will mean jobs will continue to recover at a painfully slow rate, and the unemployment rate currently sits about 2.5 percent above long-run sustainable levels. Bernanke seems to paint the good news as “things aren’t necessarily getting worse” and the bad news as “but the good-old times aren’t around the corner.”

Specifically, on the financial markets, Bernanke says that “gradual but significant progress has been achieved since the crisis. For example, credit spreads on corporate bonds and syndicated loans have narrowed considerably, and equity prices have recovered most of their losses.” However, he acknowledges conservatism in bank lending.

Above and beyond all domestic concerns is the situation in Europe. Bernanke says that “the elevated levels of stress in European economics and uncertainty about how the problems there will be resolved are adding to the risks that U.S. financial institutions, businesses, and households must consider when making lending and investment decisions. Negative sentiment regarding Europe appears to have weighed on U.S. equity prices and prevented U.S. credit spreads from narrowing even further.”

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