Fed president predicts shaky markets

The unstable housing market and higher commodity prices will continue to take their toll on the financial markets before they recover in 2009, Janet Yellen, president of the San Francisco Federal Reserve Bank, said today. “The balance-sheet pressures and broader financial market dislocations are likely to be with us for some time,” she said, speaking at the University of California, San Diego. “My expectation is that market functioning will improve markedly by 2009. But things could get worse before they get better.” Ms. Yellen noted that home prices could fall more than markets expect, which could lead to larger losses for financial institutions and further impair their ability to make new loans. On the inflation front, she noted that commodity prices will increase inflation pressure over the next few quarters. “My best guess, which could easily be wrong, is that, consistent with futures prices, commodity prices will level off and cease to put direct upward pressure on headline inflation,” said Ms. Yellen. She expected core inflation, which excludes food and energy prices, to be “better contained” although prices are running “a bit higher than I would like.” Ms. Yellen expects core inflation to be “modestly higher” in the next year, as business pass along some of their higher energy costs to their customers.