Fed chairman Bernanke stares down the interest-rate bears

“We may have more reason to believe a turning point is coming, but we haven't seen it yet,” says Lou Crandall, chief economist at Wrightson ICAP LLC, a research firm in Jersey City, New Jersey. The market “over reacted to Friday's payroll data.”

At some point, these “hiccups” will hold a message for the Fed instead of transmitting noise that can be dismissed. Crandall thinks tightening is a 2010, not a 2009, story.

'Exceptionally Explicit'

Maybe the reaction is just a bad case of jitters over the existence and execution of the Fed's exit strategy. It's true that the Fed's balance sheet will show some natural attrition as financial institutions resume their traditional lending function and the Fed imposes a penalty for using its various lending facilities. (In the old days it was considered a privilege, not a right, to borrow from the Fed's discount window.) Fed officials talk exit strategy in the same breath they reassure the markets to expect an “exceptionally low” funds rate “for an extended period.”

Instead of turning up the volume on “exceptionally low” in an effort to soothe the market, the Fed should try to be exceptionally explicit on what the egress will look like: Whether it will focus on the excess reserves banks are currently holding, which have the potential to multiply and become inflationary, or on the good old-fashioned funds rate. Then there are the financial experts in Congress. While grilling Bernanke won't be as much fun as playing pinata with bank CEOs, House Financial Services Committee Chairman Barney Frank and Senate Banking Committee Chairman Chris Dodd will surely offer him some exit guidelines, especially if the unemployment rate — up 4 percentage points in the past year to 9.4 percent — crosses the 10 percent threshold.

After all, they have to look out for the real widows and orphans.

Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own.

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