The Bernanke Bounce: Markets Rally on Fed Chairman's Inflation Comments

Fed Chairman Ben Bernanke offered his thoughts on US monetary policy, the economy and the inflationary pressures on the dollar today, and the markets liked what they heard - US equities went on a bit of tear, and the Dow Jones average was up over 212 points or almost 2% by the end of the day's trading. Ripple effects spread out to other markets including, of course, forex. The markets' interpretation of Bernanke's comments was that inflation was moderating, reducing the likelihood of future Fed interest rate hikes to curb inflationary pressures on the dollar.

Here are some excerpts from Bernanke's speech today to the Senate Committee on Banking, Housing, and Urban Affairs that give the gist of his message on inflation and the Fed's monetary outlook:

"It bears emphasizing that, because productivity growth seems likely to remain strong, the productive capacity of our economy should expand over the next few years at a rate sufficient to support solid growth in real output."

"Business investment seems likely to continue to grow at a solid pace, supported by growth in final sales, rising backlogs of orders for capital goods, and high rates of profitability. To be sure, businesses in certain sectors have experienced financial difficulties. In the aggregate, however, firms remain in excellent financial condition, and credit conditions for businesses are favorable."

"The recent rise in inflation is of concern to the FOMC [Fed Open Market Committee]. The achievement of price stability is one of the objectives that make up the Congress's mandate to the Federal Reserve. Moreover, in the long run, price stability is critical to achieving maximum employment and moderate long-term interest rates, the other parts of the congressional mandate."

"To date...moderate growth in most broad measures of nominal labor compensation and the ongoing increases in labor productivity have held down the rise in unit labor costs, reducing pressure on inflation from the cost side."

"The public's inflation expectations are another important determinant of inflation. The Federal Reserve must guard against the emergence of an inflationary psychology that could impart greater persistence to what would otherwise be a transitory increase in inflation. After rising earlier this year, measures of longer-term inflation expectations, based on surveys and on a comparison of yields on nominal and inflation-indexed government debt, have edged down and remain contained. These developments bear watching, however.

Finally, the extent to which aggregate demand is aligned with the economy's underlying productive potential also influences inflation. As I noted earlier, FOMC participants project that the growth in economic activity should moderate to a pace close to that of the growth of potential both this year and next. Should that moderation occur as anticipated, it should help to limit inflation pressures over time."

I suspect most investors skipped right to this part before dashing off to place their orders:

"The projections of the members of the Board of Governors and the presidents of the Federal Reserve Banks, which are based on information available at the time of the last FOMC meeting, are for a gradual decline in inflation in coming quarters."

If you crave the full Bernanke experience, you can read the speech in its entirety on the Federal Reserve site:

Testimony of Chairman Ben S. Bernanke
Semiannual Monetary Policy Report to the Congress, Before the Committee on Banking, Housing, and Urban Affairs, U.S. Senate, July 19, 2006

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