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EL-ERIAN: Bernanke Will Attempt A High-Wire Act In Front Of Congress This Week

tightrope high wire balancing stunt
Professional slackliner Reinhard Kleindl walks a high wire in front of the Frankfurt skyline May 25, 2013. Austrian Kleindl set a world record on Saturday by walking the highest urban high line at 185 meters (607 ft). REUTERS/Ralph Orlowski

Fed Chairman Ben Bernanke appears in front of Congress tomorrow and Thursday for his semi-annual testimony. Given the markets’ roller coaster ride of the last two months, many investors are wondering which Bernanke will turn up: Will it be the hawkish, taper-talking Chairman of May 22nd and June 19th; or will it be the re-assuring dove of July 10th who went out of his way to “talk back” notions of a premature tightening of monetary policy?

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For many investors, this important distinction speaks to the two main factors that have underpinned the impressive rally in risk assets: a reliable and rewarding liquidity paradigm that is anchored by the steadfast support of global central banks (and the Fed in particular); and the possibility of a successful handoff over time from the current phase of “assisted growth” to “genuine growth.”

I suspect that the distinction is much murkier within the Fed. Officials see the world as much more of a continuum where central bank policies can (and should) be adjusted on the basis of economic data (particularly employment and inflation); and also in response to the related assessment of the “benefits, costs and risks” of the current phase of unconventional monetary policy.

The difference between investor and the Fed’s perceptions may not stop there.

Investors parse central bankers’ remarks with a view to reflecting “terminal values” as soon as possible. The destination can be more rewarding than the journey. As such, they are inclined to jump from tapering to tightening. Moreover, upfront price adjustments can be quite violent and indiscriminate; risk appetites can change materially and quickly; and secondary liquidity can evaporate quite suddenly.

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Contrast that to central bankers who believe that orderly market adjustments can result from transparent policy communication, including the specification of thresholds and illustrative time frames (as the Fed has done for a while, and the Bank of England, Bank of Japan and European Central Bank are now pursuing or likely to do so).

It is not easy to reconcile in the short-term such competing views and behavior. Accordingly, I suspect that Mr. Bernanke will try very hard this week not to rock the boat – particularly given that global growth is slowing and, based on available partial data, U.S. GDP expansion is tracking only around 1.2% for the second quarter.

Look for Mr. Bernanke to try to strike a delicate balance: reassuring us that the Fed remains committed to supporting the economy, but also seeking to avoid encouraging additional artificial asset pricing that would further disconnect markets from underlying fundamentals.

It is indeed a high wire act for the Chairman – and with an important qualification.

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Unlike the usual setup, Mr. Bernanke is not interested in creating lots of excitement. Let us hope that he has the agility to deliver the delicate balance, along with cooperating cross winds.

Read the original article on Contributor. Copyright 2013.
Federal Reserve
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