Yellen Sees Risks to Spending From Market `Turmoil' (Update1)

By Vivien Lou Chen and Craig Torres


Dec. 3 (Bloomberg) -- Federal Reserve Bank of San Francisco President Janet Yellen said financial conditions and consumer spending have deteriorated more than she expected in the past month, signaling she supports cutting interest rates next week.

``The turmoil in financial markets has not subsided as much as I had hoped and some data on personal consumption have come in weaker than expected,'' Yellen said in a speech in Seattle. ``These developments necessitate some rethinking of my growth forecast, and have highlighted the downside skew in the risks to that forecast.''

Yellen's remarks buttress those made by Fed Chairman Ben S. Bernanke and Vice Chairman Donald Kohn last week, which stoked investors' expectations for lower rates. Bernanke and Kohn said reduced access to credit may threaten spending, and policy makers must be ``flexible'' given greater-than-usual ``uncertainty'' about the economic outlook.

``Recent data on personal consumption expenditures and retail sales are not that encouraging,'' Yellen said to a luncheon sponsored by the Seattle Chamber of Commerce Board of Trustees and Community Development Roundtable. ``They have begun to show significant deceleration -- more than was expected -- and consumer confidence has plummeted.''

Yellen, 61, previously served as a Fed governor in Washington. She doesn't vote on rates again on the Federal Open Market Committee until 2009. She also headed former President Bill Clinton's Council of Economic Advisers.

`Consensus Builder'

``Yellen is one of the consensus builders on the Federal Open Market Committee,'' said Christopher Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ in New York. ``Her comments suggest that the balance of views will shift the outlook in favor of downside economy risks at the Dec. 11 meeting.''

As of Oct. 31, the Fed in its last statement said that risks between inflation and growth were ``roughly'' balanced. Now, federal funds futures prices indicate a 38 percent probability policy makers will cut the benchmark by half a point next week, to 4 percent. Yellen is the last Fed official scheduled to speak before the Dec. 11 meeting.

The San Francisco Fed president said she has begun to hear ``a pattern of negative comments and stories'' from business contacts in her district, which accounts for about one-fifth of the U.S. economy. She added that she saw signs of ``improvement in underlying inflationary pressures'' in recent reports.

Rate Cuts

Since Sept. 18, the Fed has cut its main rate 75 basis points. Officials also lowered the cost of direct loans to banks by 50 basis points in an unscheduled meeting Aug. 16 to help offer a liquidity backstop for banks. A basis point is 0.01 percentage point.

Yellen said the drop in the dollar against major currencies since 2002 ``will help to improve our gaping trade deficit and thereby offset some of the otherwise contractionary effects of the tighter credit conditions.''

In describing her forecast, she said the economy faces a risk ``that the problems in the housing market could spill over to personal consumption expenditures in a bigger way than has thus far been evident.''

Bernanke said in a Nov. 29 speech in Charlotte, North Carolina that officials must ``judge whether the outlook for the economy or the balance of risks has shifted materially'' due to financial turbulence.

Funding Costs

Borrowing costs on loans between banks have climbed this month as mounting losses on assets linked to subprime mortgages spurred lenders to conserve cash. The three-month dollar London Interbank Offered Rate is 5.14 percent, or about 64 basis points over the Fed's target for the federal funds rate. The typical spread has been 21 basis points over the past five years.

``Indications of heightened risk-aversion continue to abound both here and abroad,'' Yellen said. Still, ``we do not appear to be at the point of an all-out credit crunch as we were in the early 1990s,'' she said.

Economic growth has slowed in seven of 12 U.S. regions from October through mid-November, with retailers ``slightly pessimistic'' about year-end holiday sales, the Fed's regional business survey showed Nov. 28. The U.S. grew at a revised annual rate of 4.9 percent in the third quarter, before the full impact of the housing recession and credit-market turmoil took hold.

``The data for the beginning of the fourth quarter in October have shown even more of a slowdown,'' Yellen said. ``The bottom line is that housing construction will likely be quite weak well into next year before beginning to turn around.''

Manufacturing in the U.S. grew in November at the slowest pace in 10 months, an industry survey showed today. The Institute for Supply Management's factory index fell to 50.8 from 50.9 the previous month.

Yellen hasn't dissented from an FOMC rate decision since becoming San Francisco Fed president in 2004 or during her tenure as a Fed governor in Washington from 1994 to 1997. She was previously an economics professor at the University of California at Berkeley.