Deficit debate may keep Fed on edge

fed_squeeze.gi.top.jpgPaul Ryan, Ben Bernanke and Barack Obama. By Paul R. La Monica, assistant managing editor


NEW YORK (CNNMoney) -- If Ben Bernanke goes to sleep at night cursing the names of Barack Obama and Paul Ryan, you can hardly blame him. The Federal Reserve chairman's job has just gotten a lot tougher.

Politicians have seen the light. Deficit cutting is their newfound religion and stimulus is an eight-letter dirty word.

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But with the economy still looking a bit shaky in the near-term and new government spending pretty much now verboten, that means the Fed may have to do even more to ensure that growth doesn't grind to a halt. Or worse.

Can you say interest rates are likely to remain "exceptionally low for an extended period?" I knew you could. Uh-oh.

The president's bold plan to cut the deficit by $4 trillion during the next dozen years and Congressman Ryan's even more audacious proposal to slash $6 trillion in spending over the next decade are clear signals that the White House and lawmakers realize they have to solve the government's addiction to debt.

That's all well and good for the long haul. But with unemployment still hovering around 9%, a housing market that remains in tatters and rising concerns about how surging gas and food prices may eat into consumers' paychecks, the U.S. economy arguably can't afford another major slump right now.

That's where Bernanke comes into play. Even though some critics of the central bank (and even some Fed members) think the Fed should raise rates sooner rather than later to whip inflation pressures now, there's a growing sense that rates may be on hold for the remainder of this year at a bare minimum.

Mark Lamkin, CEO of Lamkin Wealth Management in Louisville, Ky., said that he thinks various Fed members may continue to talk tough about inflation but that the Fed won't actually raise rates until the first quarter of 2012 at the earliest.

The Fed seems intent on doing whatever it can to prevent a double-dip recession. And there are plenty legitimate reasons why the Fed still needs to be nervous.

Jeffrey Cleveland, senior economist with Payden & Rygel in Los Angeles, said that the Fed doesn't need to worry about inflation. He argues that real estate is still a major concern.

Cleveland said housing prices could fall another 5% to 10% this year and next, and that banks may still yet face a day of reckoning with souring commercial real estate loans.

And even before Ryan and Obama unveiled their grand fiscal plans, several economists had started to lower their gross domestic product (GDP) targets for the year.

That's not a good sign since we should still be in the early stages of recovery. The Great Recession technically ended in June 2009, so it's a bit alarming that the economy may be sputtering again. The proposed budget cuts for fiscal 2011 could hurt further.

"Some think that the reduction in spending in the 2011 budget could take a little bit out off GDP. That's possible," said Joseph LaVorgna, chief U.S. economist for Deutsche Bank and a participant in CNNMoney's economist survey.

LaVorgna said he wasn't expecting that significant of a slowdown, but he is still a little concerned that the Fed may be acting too cautiously -- especially as commodity prices continue to surge.

"It seems that maybe the Fed only wants to raise rates once it's clear that moving would not be a mistake," he said.

Axel Merk, president of Merk Mutual Funds, a Palo Alto, Calif.-based money manager specializing in currency investments, agreed, adding that the Fed shouldn't peg its decisions to fiscal policy.

For one, he said that it's not clear exactly what part of either Obama's or Ryan's plans will eventually become law. In addition, he said it's debatable that low rates (as well as the Fed's two controversial rounds of so-called quantitative easing) have even helped the economy that much.

Sure, the markets seemed to like the bond buying programs, dubbed QE and QE2. But has it had a positive impact on Main Street? For many Americans, low rates and QE have only led to banks having money they are not lending, a weaker dollar and higher gas prices.

Merk added that if the Fed keeps rates too low for too long, more investors may follow the lead of bond powerhouse Pimco and start to shy away from U.S. Treasury debt.

Ultimately, it seems that Bernanke and other Fed members may feel that it's their duty to keep the economy afloat if government spending cuts start to slow things down. But maybe the Fed should give up fighting that particular battle.

"Yes, if you have draconian cuts in spending, that could throw us into recession. But to get our fiscal house in order for the long-term you may need it," said Lamkin. "The Fed may want to do QE3 but it shouldn't, even if cuts slow the economy."

-- The opinions expressed in this commentary are solely those of Paul R. La Monica. Other than Time Warner, the parent of CNNMoney, and Abbott Laboratories, La Monica does not own positions in any individual stocks.  To top of page

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