Wednesday June 7, 2006 - 14:03:49 GMT
Share This Story
Foreign Exchange Analytics - www.fxa.com
Forex: Fed Tightening As Economy Slows To Sap Dollar
In a Rodney Dangerfield moment, Fed Chairman Bernanke appears to have sought out some image consultants in recent days to resurrect his credibility with financial markets and bond traders in particular. As best I can tell there has been no preponderance of evidence to change the forecast, the base line for Fed policy making, which was so clearly expounded at the JEC testimony earlier this spring...the economy is slowing and inflation expectations are well contained.
To be fair to Bernanke, there was never a point in time when the inflation bogey was buried. Indeed the JEC testimony was quite clear that the Fed would do what it needed to if inflation surprised to the upside, which was and remains the main risk to the forecast...the slowing part of the forecast seems spot on even weeks later.
But for a new Chairman and a bipolar Treasury market more prone to extreme mood swings than stability, Gentle Ben learned he had to reinvent himself as an inflation hawk or forever lose the respect of financial markets and give seed to inflation expectations, which by the way costs the Treasury lots of money in terms of debt servicing.
So Bernanke served up what the image consultants recommended...he got tough on inflation. No mention of pause, no mention of overshooting problems at inflexion points and no emphasis on lagged effects from prior tightening.
Seems to have worked...TIPS spreads came in and the curve has flattened (2-10's inverted briefly Tuesday).
But to keep working he now must deliver...more than just a June29 rate hike. Seriously, do 25bps make or break an inflation hawk's reputation, much more contain inflation and inflation expectations for the foreseeable future? Hardly. If he chases inflation as appears to be the case knowing it lags the business cycle, he will be tightening right through the summer as the US economy slows (now seen in housing, autos, retail sales, employment, equities and commodities). Bernanke has passed neutrality and is now advocating restraint.
Raising rates in a period of economic deceleration is quite negative for the dollar and equities. Sure for the initial tightening or two the dollar will do well, but by August this will turn against the dollar as it usually does in periods of Fed overshooting on rates.
Bernanke needs new image consultants. What matters most for credibility in setting policy is consistency not mixed signals. If the Fed has a new operating methodology stick with it even if the markets don't like it, don't get it and yearn for the ad hoc days of Sir Alan.
Bernanke has painted himself into a new corner having crossed the freshly painted floor and now must deliver a series of rate hikes pandering to financial press editorial boards and bond market vigilantes. Raising rates with weak economic data nipping at the Chairman's heels is reminiscent of 1987 when Greenspan was following Volcker rate hikes with his own image-related rate increases. Well the dollar and stocks did not fair well then and will not now.
Forex Trading News
Daily Forex Market News
Forex news reports can be found on the forex research
headlines page below. Here you will find real-time forex market news reports
provided by respected contributors of currency trading information. Daily forex
market news, weekly forex research and monthly forex news features can be found
Real-time forex market news reports and features providing
other currency trading information can be accessed by clicking on any of the
headlines below. At the top of the forex blog page you will find the latest
forex trading information. Scroll down the page if you are looking for less
recent currency trading information. Scroll to the bottom of fx blog headlines
and click on the link for past reports on forex. Currency world news reports
from previous years can be found on the left sidebar under "FX Archives."