Merk Investments: Bernanke Jawbones Forex Market
Fed Chair Ben Bernanke took the unusual step during his address on the US economic outlook to talk up the dollar in his prepared remarks via-satellite before an international monetary conference held in Barcelona, Spain. The Fed chair went out of his way to follow up the pro-dollar remarks that emerged out of the most recent G-10 meeting.
In our estimation, the surprising statement by Mr. Bernanke does provide a glimpse into what has probably been for the G-10, a disappointing response by the global markets, in their attempt to provide support for a greenback still under considerable pressure. The failure of the G-10 to stem the bearish tide still awash in global foreign exchange markets in all probability required Mr. Bernanke to rhetorically intervene in the markets today.
We feel that the major structural problems-the current account deficit and looming entitlement crises-provide an overarching and significant long-term downward pressure on the dollar. The rhetorical cannons of the global central banks will do little to change the very difficult reality of the long-term downward adjustment of the dollar. The global banks know that a real intervention in the markets would prove disastrous and for now this is the best that they can do.
The second and perhaps more overlooked element in the extended statement by the Fed chair was the effort to again point out the risks to the downside vis-à-vis the strong headwinds caused by the rising costs of energy and commodities, a soft labor market, falling home prices and tight credit continue. Beyond the fact that these are the very conditions that ushered in the most recent adjustment in the value of the dollar, they will probably dampen market sentiment that had of late been aggressively pricing in a rate hike at the December meeting.
It has been our view that the economy will continue to perform inconsistently over the remainder of the year and keep the Fed on the sidelines until Q2’09, when we expect them to raise rates. These remarks support our view on rates and we think that market expectations of Fed policy will change quite quickly over the next few days.
At this juncture the Fed has to have noticed that inflation expectations have begun to inch up again using 2yr, 5yr and 10yr breakevens, in addition to the much more pronounced changes in expectations on the part of the public. The Fed will continue to pump liquidity into the markets to keep the credit market afloat until conditions in financial markets return to something approaching normalcy. Members of the Fed, including Mr. Bernanke will have to continue employing hawkish rhetoric even while they do very little to take on the very real problems with inflation that are clearly over the horizon to prevent the perceptible change in inflation expectations from becoming embedded in the psyche of both the public and the market.
Joseph Brusuelas
Merk Investments
Chief Economist/VP Global Strategy
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