If Ben Bernanke becomes the next chairman of the Federal Reserve Board in February as expected, his main concern will be helping to guide the U.S. economy to the soft landing triggered by the rate hikes started in 2004. Most economists expect that 2006 will be another overall strong year of growth, especially in the first half, and that the Fed will gradually take the fed funds rate closer to 5%.
But whether the landing is soft or hit by turbulence will depend on several challenges that will make the Fed's job more difficult. "The economy is still undergoing a transition from an above trend growth to a trend rate of between 3.2% and 3.4%, so it becomes trickier next year for the Fed," says Randell Moore, editor of the Blue Chip Economic Indicators. The consensus of 53 economists tracked by Blue Chip expects real GDP growth of 3.6% in 2005 and 3.4% in 2006, a sign of general confidence in the year ahead, although growth is expected to cool in the third and fourth quarters.
Perhaps the worst case scenario would involve a sharp spike in long-term interest rates that could move the economy closer to a recession in 2007. Although the yield on the 10-year Treasury note has risen by about 100 basis points in the last two years, its current yield at around 4.5% remains tepid, and a sharp spike remains a remote possibility in the near term. But with rates on the rise in Europe, investors may find other places to put their cash. "Ben Bernanke is a risk factor," says John Lonski, chief economist at Moody's Investors Service, referring to the perceptions about what the next Fed chairman will do. "It's a change in leadership at the Fed that might reduce the willingness of foreigners to lend to the U.S." Although regarded as a fundamental inflation fighter in the Greenspan mold, Bernanke is an unknown when it comes to his communication skills and ability to manage in times of crisis–two jobs at which his predecessor excelled. "The biggest risk for the marketplace is that [Bernanke] will do what new guys do–over-tighten to prove he's tough on inflation," says Cary Leahey, senior managing director at Decision Economics in New York. Leahey notes, however, that the pressure on Bernanke to hike has been reduced after the Federal Open Market Committee decided in December to withdraw accommodation language that predisposed it to more rate incresaes.
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