A glance at recent commentary by various Federal Reserve officials reflects one thing: the FOMC is becoming concerned that the markets see reductions in the fed funds rate as a cure-all for the current economic and financial market woes. Indeed, with upside inflation risks remaining strong, the central bank is likely a bit worried about price stability. However, given the continuous deterioration in economic conditions and the persistent credit crunch, the FOMC will likely cut rates further, albeit at a slower pace. Fed fund futures are pricing in a 25bp reduction on April 30, and as we’ve learned over the past few months, the markets are almost always right.
[B]Yield Spread Analysis 03/25 – 04/01[/B]
Despite an initial dip following the FOMC’s decision last Tuesday to cut the fed funds rate by 75bp to 2.25 percent, short-term yields have rocketed higher across the G-10 nations – with the exception of Australia and New Zealand – as the financial markets stabilize and risk aversion fades. Indeed, the yield on short-term US debt gained over 13bp, while yields in the UK and Canada are both up over 27bp. At the same time, stock markets around the world have bounced from multi-year lows, though it remains to be seen if these indexes can hold on to their gains. As we’ve seen in the past, it doesn’t take much to trigger sharp sell-offs of risky assets like equities or forex carry trades.
Looking ahead, FOMC members will likely remain mum on the economy, as they slowly put their expansion of lending facilities to work in order to stave off a more pronounced credit crunch. Meanwhile, upcoming economic data out of the US could shake up Treasuries if they prove to be very disappointing. Nevertheless, risk aversion trends remain the primary driver of the markets these days, so fixed income, forex, and equity traders should all keep an eye out for news from the financial sector.
For a full schedule of upcoming event risk, see the DailyFX Calendar.
[B]Fed: Will Inflation, Moral Hazard Concerns Prevent Further Rate Cuts?[/B]
A glance at recent commentary by various Federal Reserve officials reflects one thing: the FOMC is becoming concerned that the markets see reductions in the fed funds rate as a cure-all for the current economic and financial market woes. Indeed, with upside inflation risks remaining strong, the central bank is likely a bit worried about price stability. However, given the continuous deterioration in economic conditions and the persistent credit crunch, the FOMC will likely cut rates further, albeit at a slower pace. Fed fund futures are pricing in a 25bp reduction on April 30, and as we’ve learned over the past few months, the markets are almost always right.
[U]Frederic Mishkin, Federal Reserve Board Governor (Voting Member)[/U]
“When one member advocates a more accommodative policy stance than the other members, it may not be clear whether that reflects a more negative outlook for the economy or a greater willingness to allow inflation to settle in or near the top of the comfort zone.” – March 28, 2008
[U]Charles Plosser, Federal Reserve Bank of Philadelphia President (Voting Member)[/U]
“Unfortunately, what the public has come to expect of monetary policy, and central banking more generally, has risen considerably over the years. Indeed, there seems to be a view that monetary policy is the solution to most, if not all, economic ills.” – March 28, 2008 [U]Gary Stern, Federal Reserve Bank of Minneapolis President (Voting Member)
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“Recent events have likely reaffirmed and strengthened some creditors’ expectations of support, or have created those expectations for the first time, yet the Fed simply cannot allow widespread perceptions of government support to pervade the financial system.” – March 27, 2008 [U]Charles Evans, Federal Reserve Bank of Chicago President (Alternate Voting Member)
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“At 2.25 percent, the current federal funds rate is accommodative and should support stronger growth. Indeed, because monetary policy works with a lag, the effects of last fall’s rate cuts are probably just beginning to be felt, and the cumulative declines should do more to promote growth going forward.” – March 27, 2008
[B]ECB: Hawkish Inflation Bias Will Continue to Support EUR/USD[/B]
The European Central Bank has not backed off from their hawkish inflation bias by any means, and with good reason: CPI remains well above their comfort zone and upside inflation risks persist. However, there are mixed views on the impact of a US economic slowdown on the Euro-zone’s economies. Some ECB members remain optimistic, but most are leery of the potential for weak US export demand and a credit crunch to throw a wrench in the Euro-zone growth engine. Nevertheless, until CPI falls back markedly, the ECB will not even consider cutting rates, which should prevent EUR/USD from falling significantly lower in coming months.
[U]Jean-Claude Trichet, European Central Bank President[/U]
“Inflation is likely to remain significantly above 2 percent in the coming months and moderate only gradually later in the year. The governing council remains strongly committed to preventing second-round effects and the materialization of upside risks to price stability over the medium term.” – March 26, 2008 [U]Lorenzo Bini Smaghi, European Central Bank Executive Board Member
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“The main reason (for high inflation) is linked to the global economy. The strong growth of certain areas boosts demand for raw materials, particularly energy and food. Without them, inflation in the Euro-zone would be 1 percent lower. What influences the cost of life, is largely out of our control, but it’s temporary.” – April 1, 2008
[U]Axel Weber, European Central Bank Governing Council Member[/U]
“Given this volatile financial market climate, one has to continue anchoring solidly inflationary expectations at low levels. The current level of interest rates and our monetary policy, which is oriented to price stability, contribute to achieve these goals. In the months ahead, too, we will watch all developments very closely and act if it is necessary to fulfill our mandate, namely to secure price stability.” – March 28, 2008
[U]Guy Quaden, European Central Bank Governing Council Member[/U]
“We are surely not immune. But we are more resilient than in the past. In general, until now, the resilience of our European exports was better than in the past, and business confidence seems to remain solid. But financial markets are still in large part driven by Wall Street, and the excessive volatility of the foreign exchange market is clearly a negative risk.” – March 27, 2008