|
Although briefly noting encouraging productivity, employment, and capital spending trends, Mr. Bernanke essentially used his first six paragraphs in yesterday’s speech to give his clearest warning yet that the Fed sees an economic slowdown gripping the US economy. Incidentally, and for those with a keen eye, Bernanke also started planting the seeds of blame for when, and if, this slowdown becomes more pronounced than expected:
“Should U.S. economic growth moderate as expected, sustaining the global expansion will require a greater reliance by our trading partners on their own domestic spending as a source of growth.” (emphasis added):
After six paragraphs of caution you would expect – given that Greenspan always seemed to have something dovish to say - that Bernanke would add some token words of optimism. Wrong. In fact, in the final four paragraphs Bernanke, rather explicitly, adorned a set of sharp talons. Remember, these cautionary statements arrived after six paragraphs warning of moderating economic growth. Here are the highlights:
- Para 7: “…core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth.”
- Para 8: “…the volatility of these [oil] and other commodity prices is such that possible future increases in these prices remain a risk to the inflation outlook.”
- Para 9: “…the Committee will be vigilant to ensure that the recent pattern of elevated monthly core inflation readings is not sustained.”
- Para 10: “…the Committee must continue to resist any tendency for increases in energy and commodity prices to become permanently embedded in core inflation.”
After last week’s weaker than expected jobs report not many economists expected Bernanke to offer such a hawkish speech. For that matter, after Bernanke suggested that the Fed could pause (regardless of inflationary pressures) during his April 27 Testimony, few expected the Fed to adopt a more hawkish tone today. After all, more evidence of a slowdown, particularly in the US housing market, continues to arrive almost daily.
But alas, the Fed’s intentions have finally been made clear: commodity prices (some would say commodity bubbles) must fall, and any means necessary to achieve this goal will be implemented post-haste.
Bernanke’s Words a Cause and Cure for Market Volatility
The largest daily drop in the US dollar index in 2006 was on Monday April 17. For those of you with a good memory, April 17 was the day when the Journal’s Greg Ip reported that some Fed members were not convinced that the Fed would raise interest rates in June. Confirmation of a possible Fed pause arrived (in the Fed minutes) on April 18, and Bernanke confirmed that a pause was possible during his testimony on April 27. The dollar only formed a near-term bottom on May 5, after stronger than expected inflationary data arrived and Fed pause hopes were thrown into question.
 |
The potential for a June Fed rate hike jumped to 76 percent after Bernanke’s words yesterday, up from 48 percent on Friday. Accordingly, the argument can be made that in attempting to quell commodity prices Mr. Bernanke has, perhaps by design, offered some support to the US dollar. However, by temporarily taking currency uncertainty/volatility out of the equation (higher interest rates favor a steady USD), Bernanke creates equity and bond market uncertainty/volatility (rising interest rates are usually bad news for stocks). The applicable Fed slogan today is: when in doubt try to avert a US dollar route.
But what about Longer-Term?
If no financial crisis arrives during the next two weeks the Fed will raise interest rates for the 17th-time in a row. In fact, if commodity prices spike again before June 28 the Fed could be inclined to raise rates by 50 bp. Realizing that US home prices have probably already peaked and that the Fed’s actions could inflict even more damage, the stance of monetary policy after June is highly uncertain.
What is certain is that after a shaky start Bernanke has grown aware that his comments can move the markets. The theoretically inclined Bernanke may even be receptive to the fact that his market moving words can be used as a tool when conducting monetary policy. Thus, under the umbrella of deploying reverse psychology, by the June meeting Mr. Bernanke and company may be adopting a one and done tenor. If so, this could be a warning to investors that the ‘period of transition’ - from above average to below average growth – is not only ‘well underway’, but at threat of sparking a recession.
What should be remembered is that on May 5 – the day the US dollar bottomed and US stocks were slammed lower – current consumer attitudes in the Michigen confidence report plunged by the most in the 28-year history of the report. The investor must remember this shocking report and commit the data that has been released since May 5 to memory. Why? Because with the US economy already slowing, the Fed is gauging short term policy success/failure by the action in commodity and currencies markets: Near term economic growth be damned, the longer-term threat of a commodities bubble must be stopped via higher interest rates.
Mr. Bernanke’s words and actions could build a temporary floor under the US dollar, but perhaps only until the roof caves in.
 |
 |
|
