US Fed - All Bark and No Bite?

US Fed – All Bark and No Bite?
ECB – Rate Hike Prospects Lose Momentum

Yield Spread Analysis 03/27 – 04/03

Risk aversion has played a key role in the trade of everything from FX to fixed income markets since the equity crunch on February 28th. Over the past week, traders have started to move towards more risky positions and thus, away from bonds as tensions in Iran have started to die down. European and Canadian yields were the greatest beneficiary, with the country’s respective curves steepening significantly. Meanwhile, the Japanese yield curve steepened, but rates on both ends of the curve weakened amidst a slew of disappointing economic releases as prices slipped into deflation and business sentiment diminished.
Looking forward, Australian and British rates could be sent reeling as the Reserve Bank of Australia and the Bank of England are scheduled to make monetary policy decisions this week. While neither is unanimously expected to raise rates, hot economic releases have left the risks of the decision to the tightening side.

US Fed – All Bark and No Bite?

While inflation pressures remain high, tepid growth and a feeble housing sector will likely keep the Federal Reserve neutral. However, commentary from Fed officials seems to be less about transparency and more about managing the market’s expectations:

[U]Ben Bernanke, Federal Reserve Chairman (Voter)

[/U]“At this juncture … the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained.” – March 28, 2007

“To date the incoming data have supported the view that the current stance of policy is likely to foster sustainable economic growth and a gradual ebbing in core inflation?I want to emphasize that we have not shifted away from an inflation bias. Our policy is still oriented towards control of inflation, which we consider to be at this time to be the greater risk?There seems to be a sense that expansions die of old age, that after they reach a certain point, then they naturally begin to end. I don’t think the evidence really supports that.” – March 28, 2007

[U]William Poole, Federal Reserve Bank of St. Louis President (Voter)

[/U]“Inflation is a major concern and if inflation were to head up in a convincing way from the current level, I could be in favor of a rate increase at some point.” – April 2, 2007

[U]Michael Moskow, Federal Reserve Bank of Chicago President (Voter)

[/U]“My assessment is that the risk of inflation remaining too high is greater than the risk of growth falling too low. The most recent data on housing have been mixed and downside risks remain.” – March 28, 2007

The US Senate is doing everything in their power to get China to change their monetary policy. Now that the Commerce Dept. has announced a hike in tariffs on Chinese paper imports, the question remains: are protectionist measures really the answer?

[U]Senator Charles Schumer (D-NY)

[/U]“Well-crafted legislation – WTO-compliant and strong and effective – is likely to pass with a veto-proof margin during this Congress. That’s the message I hope the Chinese and the Bush administration take away from this hearing.” – March 29, 2007

Senator Max Baucus (D-MT), Senate Finance Committee Chairman

“Today’s hearing showed that China must change its currency regime, and it is capable of doing so. Failing to accelerate exchange rate reform is bad for China, bad for America and bad for the global economy.” – March 29, 2007

[B]ECB[B] – Rate Hike Prospects Lose Momentum

[/B][/B]The European Central Bank’s Mr. Trichet and Mr. Gonzalez-Paramo remain staunchly hawkish due to inflation risks, and have led the markets to believe that 4.00 percent is in the cards before mid-year:

Jean-Claude Trichet, European Central Bank President

“In the opinion of the ECB Governing Council the outlook for price developments in the medium term remains characterized by upside risks?Every observer, investor, every saver, in Europe and the rest of the world, knows that we will do what is necessary to ensure price stability?They also know our policy is not to pre-commit in any respect to future action. We will do what is necessary, but we never unconditionally pre-commit.” – April 2, 2007

“This dynamism was one of the details which the ECB took into account when making its decisions. Besides I would say that everything that nations can do to contain these adverse events would be encouraging. But I would like to emphasize that we are seeing a certain slowdown in national housing markets, particularly in Spain.” – April 2, 2007

“Euro zone growth is probably slightly above its potential rate.” – March 29, 2007

[U]Jose Manuel Gonzalez-Paramo, European Central Bank Executive Board Member

“The balance of inflation risks is clearly on the upside.” – March 28, 2007

However, not all members of the ECB see the need for such vigilance:

[U]Mitja Gaspari, European Central Bank Governing Council Member

[/U]“3.75 percent is okay at the moment,” and adds that he would not be surprised to see the ECB rate raised to 4 percent. However, he notes, “If you look at the inflation rate, if you look at some movements in the exchange rate as well, the monetary policy stance is getting really less accommodative than it used to be.” – March 29, 2007