Following weeks of mixed commentary from various FOMC members, central bankers have been relatively mum over the past few days as the highly anticipated monetary policy decision looms on Tuesday afternoon. Indeed, Bernanke stuck to talking about the government’s recent subprime proposal while Yellen noted improvements in inflationary pressures, which is somewhat surprising since the most recent CPI reports showed both core and headline price pressures building. Nevertheless, an under-the-radar speech by Kroszner essentially said that problems in the housing sector would get worse before they would get better. Will the FOMC use this as part of their logic for cutting rates today? Will 25bp be enough? The markets are betting that they will indeed cut by 25bp, but see a 50bp reduction as more likely than no change at all. Regardless, the FOMC rate decision and policy statement are sure to draw much attention and more importantly, could spark wild price action in the US Dollar, Treasuries, and the Dow.
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[B]Yield Spread Analysis 12/04 – 12/11[/B]
A rebound in global equity markets helped weigh government bonds down over the past week, leading long-term yields to rocket higher. Indeed, the yield on 10-year Treasury Notes, CGBs, and Gilts all surged nearly 20bp. Does this mean that the outlooks for the US, Canadian, and UK economies look resilient? Not necessarily. First of all, short-term yields rose as well, leading the yield curve in Canada to actually invert even more. Furthermore, the shift in government bonds had more to do with the fact that traders became more risk seeking, as the economic scenario for these regions have, if anything, become more dour. Indeed, the Bank of Canada and the Bank of England both unexpectedly cut interest rates as the credit crunch served as far too great a risk to the financial markets and economic growth.
In the US, the Federal Reserve is widely anticipated to decrease the federal funds rate by at least 25bp, though traders are speculating that there is some potential for a 50bp cut. However, it will likely be the bias reflected in the bank’s policy statement that will determine price action in fixed income, FX, and equity markets. If Bernanke & Co. suggest that they will not cut rates again in January, Treasuries, the greenback, and the Dow may react as though there was no monetary policy action at all this time around.
[B]US Fed: Traders Are Betting That A 25bp Cut Is Guaranteed, But Are They Wrong?
Following weeks of mixed commentary from various FOMC members, central bankers have been relatively mum over the past few days as the highly anticipated monetary policy decision looms on Tuesday afternoon. Indeed, Bernanke stuck to talking about the government’s recent subprime proposal while Yellen noted improvements in inflationary pressures, which is somewhat surprising since the most recent CPI reports showed both core and headline price pressures building. Nevertheless, an under-the-radar speech by Kroszner essentially said that problems in the housing sector would get worse before they would get better. Will the FOMC use this as part of their logic for cutting rates today? Will 25bp be enough? The markets are betting that they will indeed cut by 25bp, but see a 50bp reduction as more likely than no change at all. Regardless, the FOMC rate decision and policy statement are sure to draw much attention and more importantly, could spark wild price action in the US Dollar, Treasuries, and the Dow:[/B]
[U]Ben Bernanke, Federal Reserve Chairman (Voting Member)[/U]
“The streamlined process for refinancing and modifying sub-prime adjustable rate mortgages announced today is a welcome step in helping Americans protect their homes and communities from the consequences of unnecessary foreclosures.” – December 7, 2007
[U]Randall S. Kroszner, Federal Reserve Governor (Voting Member)[/U]
“Looking forward, we expect the substantial payment increases often experienced at the first interest-rate reset to result in higher delinquencies…In addition, tightening credit conditions…suggest that refinancing may become more difficult. In the past, many borrowers experiencing these resets were able to avoid the payment increases by refinancing their mortgages. The recent declines in house prices and the current tighter credit conditions, however, reduced the viability of this option for significant numbers of borrowers.” – December 6, 2007
“The Board recognizes the magnitude of the challenges facing mortgage borrowers today. We understand the uncertainty and harm being experienced by consumers across the country as the housing market challenges continue.” – December 6, 2007
[U]Janet Yellen, Federal Reserve Bank of San Francisco President (Non-voting Member)[/U]
“Signs of improvement in underlying inflationary pressures are evident in recent data.” – December 4, 2007
[B]ECB: Going Against the Grain[/B]
[B]Last week, the European Central Bank made it clear that they remained staunchly hawkish in the face of mounting inflation pressures, even as the Bank of England and Bank of Canada cut rates while the Federal Reserve was (and is still) expected to decrease rates by 25bp on Tuesday. While the uncertainty surrounding the downside risks to growth and the reappraisal of risk in the financial markets provided good reason to consider cutting rates, Trichet showed no sign of backing down from his goal of maintaining price stability. Will this be to the detriment of the economy and the markets, or will Trichet be remembered for keeping inflation in check?[/B]
[U]Jean-Claude Trichet, European Central Bank President[/U]
“Against this background, and with money and credit growth remaining very vigorous in the euro area, the Governing Council stands ready to counter upside risks to price stability….However, the reappraisal of risk in financial markets is still evolving and is accompanied by continued uncertainty about the potential impact on the real economy. We will therefore monitor very closely all developments.” – December 6, 2007
[U]Jose Manuel Gonzalez-Paramo, European Central Bank Executive Board Member[/U]
“It (a strong Euro) can make things easier or not. But it is never our objective. We haven’t put off any increase (in rates). We never commit ourselves beforehand…(but) have upside inflation risks intensified? They have. Do they exist now? They do. Have they intensified? Doubtless. The ECB is ready to act firmly to avoid the materialization of second-round effects in the fixing of salaries and prices.” – December 10, 2007
[U]Juergen Stark, European Central Bank Executive Board Member[/U]
“In the ECB governing council we came to another conclusion - that the risks to the stability of prices are, in fact, pointed upwards.” – December 10, 2007
[U]Erkki Liikanen, European Central Bank Executive Board Member[/U]
“The latest information confirms the existence of strong short-term upward pressure on inflation.” – December 10, 2007
[B]Compiled by Terri Belkas, Currency Analyst for DailyFX.com[/B]