Many FOMC members have made a point of signaling no intention of cutting rates again in the near-term, as record high oil prices significantly raise inflation risks in the economy. However, the markets appear to be trying to force the bank’s hand as federal fund futures currently price in a 96 percent chance of a 25bp rate cut in December. With less than a month until Bernanke & Co. convene again, they are working the press overtime to convince investors that they don’t have to make policy more accommodative. Will the markets buy it and cut back speculation of a rate cut? Furthermore, can it revive the beleaguered US dollar? After Tuesday’s release of the October FOMC minutes, we may finally get our answer.
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[B]Yield Spread Analysis 11/13 – 11/20[/B]
Flight-to-safety remained the primary driver of government bond markets over the past week amidst broad weakness in global equities. Bonds with longer term maturities saw their yields drop the most, with 10-year Treasuries, Canadian Government Bonds, Australian Government Bonds, and Gilts all down more than 10bp. Indeed, the shift in UK bonds was not entirely surprising, as the Bank of England’s Quarterly Inflation Report proved to be somewhat dovish given suggestions that they would move to cut rates in the first quarter of 2008.
As long as stock markets like the Dow, FTSE 100, and Nikkei continue to take a hit, government bonds are likely to move higher, sending yield spiraling lower. However, this may also lead to some mis-pricing of interest rate cut possibilities. For example, Fed fund futures currently price in a 96 percent chance of a 25bp cut in December, and given recent commentary from some FOMC members, this may be unrealistic and could increase price risks for the equity markets ahead of the actual meeting. Tuesday’s release of the October FOMC meeting minutes may help to quell some of this speculation as updated forecasts for growth and inflation will be included and Bernanke & Co. could express a hawkish stance. If they don’t, however, the greenback could continue to take on new lows.
[B]US Fed: Futures Price In A 96% Chance Of A Rate Cut – Are The Markets Fooling Themselves?
Many FOMC members have made a point of signaling no intention of cutting rates again in the near-term, as record high oil prices significantly raise inflation risks in the economy. However, the markets appear to be trying to force the bank’s hand as federal fund futures currently price in a 96 percent chance of a 25bp rate cut in December. With less than a month until Bernanke & Co. convene again, they are working the press overtime to convince investors that they don’t have to make policy more accommodative. Will the markets buy it and cut back speculation of a rate cut? Furthermore, can it revive the beleaguered US dollar? After Tuesday’s release of the October FOMC minutes, we may finally get our answer:[/B]
[U]Ben Bernanke, Federal Reserve Chairman (Voting Member)[/U]
“The goal is for Fed officials to provide the public with greater and more timely insight into the Federal Open Market Committee’s views of the economic outlook and the risks to that outlook.” – November 14, 2007
[U]Randall Kroszner, Federal Reserve Governor (Voting Member)[/U]
“In sum, in September and again in October, I believed that achieving the FOMC’s statutory mandate to promote price stability and maximum employment would best be accomplished by lowering the target federal funds rate. With those actions, however, the downside risks to economic growth now appear to be roughly balanced by the upside risks to inflation. I would add that the limited data and information received since the October FOMC meeting have not changed my thinking in this regard.” – November 16, 2007
[U]Richard Fisher, Federal Reserve Bank of Dallas President (Alternate Voting Member)[/U]
“Too many people think we are preoccupied with economic growth at the expense of doing our job on the inflation rate. We are not. There is as yet no indicator that the economy is falling off the table.” – November 14, 2007
“I find that there is greater symmetry of risk between growth and inflation than is commonly surmised. Our concern about inflation at the Dallas Fed stems from two more pervasive sources – food and energy, where we foresee a risk of a more pernicious pass-through effect than we saw in the recent price increases of underlying commodities…A spread of the current magnitude between food price inflation and the core index occurred on several occasions between 1957 and 1980. But we have not seen it in a quarter century.” – November 14, 2007
[U]Thomas Hoenig, Federal Reserve Bank of Kansas City President (Voting Member)[/U]
“I am not at all opposed to necessary actions either way for the future…Right now I am in a wait-and-see mode, at least until the December meeting…If the data comes forward in a weaker form…then I think it would require an action on the Federal Reserve to offset that. On the other hand, if these strong factors carry forward, and they have in past financial crisis, we have to be mindful of that as well.” – November 15, 2007
“While we in no way want the economy to slip into a slower-growth environment, we also want to be careful that we follow the dual mandate and watch our inflation numbers as well…Inflation doesn’t increase in big jumps. It increases in little steps…Food and energy are increasing and they are an important part of every consumer’s budget, and I think that’s a factor that we can’t lose sight of.” – November 15, 2007
[B]ECB: Neutral Policy for Risky Times[/B]
[B]If there’s anything the European Central Bank has been clear and transparent about, it’s their view that current conditions are risky. During the recent G20 meeting, Trichet noted downside risks to growth while other ECB council members have commented on the upside risks for inflation. It appears that until the potential for what Trichet calls a “disorderly unwinding of global economic imbalances” subsides, the ECB will keep rates steady. Nevertheless, their bias is undoubtedly hawkish:[/B]
[U]Jean-Claude Trichet, European Central Bank President[/U]
“Global growth continues at an encouraging pace even if it is perhaps slightly lower than…5 percent…The risks overall are on the downside and those, of course, stem from the risk of further oil and commodity price rises as well as food price rises…We have to be alert, not to be complacent in any respect.” – November 19, 2007
[U]Klaus Liebscher, European Central Bank Governing Council Member[/U]
“The outlook for price stability over the medium term is subject to upside risks as increased oil, commodity and food prices as well as the favorable labor market situation are likely to make higher wage settlements possible.” – November 19, 2007
[U]Juergen Stark, European Central Bank Governing Council Member[/U]
“It is crystal clear that recognition of the benefits of gathering further information does not imply that monetary policy does not remain resolutely focused on the maintenance of price stability and remains ready to act in a firm and timely manner to address the strengthening of upward pressures and risks to the outlook for price stability.” – November 16, 2007
[U]Peer Steinbrueck, German Finance Minister[/U]
“Despite the turbulence on global financial markets in recent months, the German economy continues to be in good health. The German economy’s power for growth has become more solid over the last quarter.” – November 19, 2007
[B]Written by Terri Belkas, Currency Analyst for DailyFX.com[/B]