Comments by various FOMC members – including Chairman Bernanke – have led the markets to ramp up speculation that the Fed will indeed cut rates next week. However, in recent days, the lack of fresh dovish rhetoric has left the stock markets floundering, though futures are still pricing in a 60 percent chance of a 25bp cut and a 40 percent chance of a 50bp cut. Will Bernanke & Co. really opt to ignore their price stability mandate? Given the market’s bias, it appears possible, but a re-pricing of this risk could occur on Friday when US NFPs are released. If labor market conditions remain robust enough – suggesting consumption growth will weather the holiday shopping season – the FOMC could surprise everyone and hold off on cutting rates until Q1 2008.
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[B]Yield Spread Analysis 11/27 – 12/04[/B]
By and large, flight-to-safety remains the primary driver of government bond markets – as has been the case for weeks on end – as credit crunch fears loom large. US Treasuries saw the largest shift, with both short-term and longer-term yields down about 10bp, as the markets aggressively price in a December rate cut by the Federal Reserve. However, other central banks may steal the limelight this week as the Bank of Canada, Reserve Bank of Australia, Reserve Bank of New Zealand, Bank of England, and European Central Bank will all announce rate decisions. No policy action is expected by any of the banks, but policy statements reflecting a clear bias could spark volatile price action. The most closely watched decisions will be from the BOE and ECB, as significant upside inflation risks and major downside risks to growth leave their respective policy boards in a tough position. In the end, the BOE is likely to prove a bit more dovish than the ultra-hawkish ECB.
Nevertheless, traders should also keep an eye out for spikes in risk aversion – along with fundamentals – as these factors will likely remain a primary driver of price action in FX, fixed income, and equity markets in coming weeks.
[B]US Fed: Can They Ignore Price Stability In Favor of Growth? The Markets Think So.
Comments by various FOMC members – including Chairman Bernanke – have led the markets to ramp up speculation that the Fed will indeed cut rates next week. However, in recent days, the lack of fresh dovish rhetoric has left the stock markets floundering, though futures are still pricing in a 60 percent chance of a 25bp cut and a 40 percent chance of a 50bp cut. Will Bernanke & Co. really opt to ignore their price stability mandate? Given the market’s bias, it appears possible, but a re-pricing of this risk could occur on Friday when US NFPs are released. If labor market conditions remain robust enough – suggesting consumption growth will weather the holiday shopping season – the FOMC could surprise everyone and hold off on cutting rates until Q1 2008:[/B]
[U]Ben Bernanke, Federal Reserve Chairman (Voting Member)[/U]
“The outlook has … been importantly affected over the past month by renewed turbulence in financial markets, which has partially reversed the improvement that occurred in September and October. We at the Fed will have to remain exceptionally alert and flexible…In making its policy decision, the committee will have to judge whether the outlook for the economy or the balance of risks has shifted materially. In doing so, we will take full account of the implications for the outlook of both the incoming economic data and the ongoing developments in the financial markets.” – November 30, 2007
[U]Donald Kohn, Federal Reserve Vice Chairman (Voting Member)[/U]
“Uncertainties about the economic outlook are unusually high right now. In my view, these uncertainties require flexible and pragmatic policymaking – nimble is the adjective I used a few weeks ago.” – November 28, 2007
[U]William Poole, Federal Reserve Bank of St. Louis President (Voting Member)[/U]
“I would not want people in the markets to believe that I, at any rate, would be so concerned about the moral hazard argument that I wouldn’t possibly advocate a 25 basis point or a 50 basis point cut, or whatever might be on the table…Provided that the central bank does not sacrifice long-term price stability, it can and should respond to new information indicating an increased risk of recession.” – December 3, 2007
[U]Richard Fisher, Federal Reserve Bank of Dallas President (Alternate Voting Member)[/U]
“There are people at the (FOMC) table, myself included, that are very concerned about inflationary pressure. I don’t think we’re done in terms of getting it to where we want it to get. At the same time, we have to be very mindful of the fact that in order for capitalism…to continue to function, we have to have a healthy working financial market. And so that is where we presently stand…Obviously, you can’t ignore the credit markets … (but) the Fed will not be bullied by markets…If you look at the broader prices indices, the CPI, the PCE, I’m uncomfortable personally with those numbers.” – November 29, 2007
[U]Janet Yellen, Federal Reserve Bank of San Francisco President (Non-voting Member)[/U]
“Since the October (FOMC) meeting, financial conditions have deteriorated, and we have seen some unexpected softening in the economic data. These developments necessitate some rethinking of my growth forecast, and have highlighted the downside skew in the risks to that forecast…additional data bearing on the outlook will become available before the FOMC’s meeting next week, and this information must also be factored into an assessment of the economy’s prospects.” – December 3, 2007
[B]BOE: Can Mervyn King Maintain A Hawkish Majority?[/B]
[B]It is well known that BOE Governor King is a staunch hawk, but tight credit markets, downside risks to growth, and mounting inflation pressures have put all of the policy makers in a tough spot. Though the general rhetoric from the central bank has focused on inflation, fears that the credit crunch is worsening creates the possibility that über-doves like Blanchflower and Gieve may be able to convince the majority that they must enact a pre-emptive rate cut this Thursday:[/B]
[U]Mervyn King, Bank of England Governor[/U]
“The world economy looks softer now than it did then (in August). There’s uncertainty of how much the US economy will affect the world economy and the banking system…I’ve not received the impression that the tightening of credit conditions and financial turmoil have had a big impact on decisions.” – November 28, 2007
“In recent months the near-term outlook for both inflation and growth has become less benign, complicating life for the Monetary Policy Committee. The Committee’s current judgment is that the most likely outcome is for output growth to slow and inflation to rise, at least for a period.” – November 29, 2007
[U]Tim Besley, Bank of England Monetary Policy Committee Member[/U]
“There’s still a fair amount of inflationary pressure out there and we will have to see to what extent events in the real economy reflect that…I would say that (risks) are slightly to the upside on inflation and slightly to the downside to growth.” – November 28, 2007
[U]Rachel Lomax, Bank of England Deputy Governor[/U]
“We’re clearly at a different place to where we were…With rates at 5.75 percent it’s difficult to argue it’s accommodative…What’s happening to commodity and oil prices is a big concern just at the moment and coming up to the big season for pay awards, we’re conscious that RPI hasn’t fallen in the way we would expect to happen. We’re looking very closely at the labor market and wage settlements.” – November 28, 2007
“Our forecasts are that interest rates are going to be easing back in the next two years…these are projections, but they are not promises…we are still gathering the first bits of evidence of a slowdown, rather than saying it’s actually here.” – November 28, 2007
[U]Andrew Sentence, Bank of England Monetary Policy Committee Member[/U]
“Judging the appropriate monetary policy response will not be easy…we will need to weigh the evidence on the extent and likely duration of the slowdown in UK growth against the impact of inflationary pressures coming through from the global economy and their potential impact on inflation expectations.” – November 28, 2007
“These upside inflationary risks from oil and other commodity prices need to be weighed in the balance against the downside risks to growth - and hence inflation - from the recent financial turmoil.” – November 28, 2007
[U]David Blanchflower, Bank of England Monetary Policy Committee Member[/U]
“I think they (interest rates) should come down now so we can get ahead of the curve.” – November 27, 2007
“My concern is that output would decline more on the downside than others had thought. The concern I have is that if the housing market declines, there will be a decline in consumption.” – November 28, 2007
[B]ECB: Hawkish, But No Hike.[/B]
[B]The fact that price stability remains the primary concern of the ECB comes as little surprise, as their hawkish bias has been justified by November CPI estimates of 3.0 percent, which is well above their 2.0 percent ceiling. However, just like the UK and the US, Euro-zone credit conditions are still extremely tight and financial markets remain easily spooked and prone to volatility. As a result, the markets are betting that the ECB will leave rates unchanged at 4.00 percent on Thursday, but the deal-breaker for Euro bulls is whether or not Trichet will remain hawkish in his subsequent policy statement: [/B]
[U]Jean-Claude Trichet, European Central Bank President[/U]
“We must avoid that price increases for oil, energy and food are extended to the entire economy. We will use all our instruments for this.” – November 30, 2007
[U]Jose Manuel Gonzalez-Paramo, European Central Bank Executive Board Member[/U]
“Let me say clearly that I consider a situation in which the central bank would reduce its interest rate with a view to strengthening asset prices and banks’ balance sheets as…in the case of the Euro system, simply unthinkable. This is a situation that would obviously open up issues of moral hazard and that no central bank committed to price stability would ever contemplate. Let me…reassure the concerns of those who believe that we might be tempted to temporarily forgo our commitment to price stability out of worries about financial market developments – this is a temptation that neither I nor my colleagues at the ECB’s governing council have ever experienced.” – December 3, 2007
[U]Klaus Liebscher, European Central Bank Governing Council Member[/U]
“Upward inflation risks prevail in the Euro-zone.” – November 29, 2007
[U]Jean-Claude Juncker, Euro-Group President[/U]
“We cannot ignore the increasing inflation risks. The economy is robust but slowing down a bit and we have to face these two risks.” – December 3, 2007
[U]Peer Steinbrueck, German Finance Minister[/U]
“I’m not concerned about inflation. Economic development has gained momentum… figures are good. There are some risks – the dollar exchange rate and oil prices might dampen economic development – but we have good forecasts for 2008.” – December 3, 2007
[B]Written by Terri Belkas, Currency Analyst for DailyFX.com[/B]