Fed Chairman’s Testimony Spooks Markets

Weekly Update

On Monday, Federal Reserve Chairman Ben Bernanke, delivered the Semiannual Monetary Policy Report to Congress. The highlight of the report was the Chariman’s characterization of the economic outlook as “unusually uncertain.” While Bernanke still anticipates growth in the economy, the rate of growth is now expected to be slower than previously thought. The Fed is forecasting GDP growth of 3 to 3.5 percent in 2010, and 3.5 to 4.5 percent in 2011 and 2012. The unemployment rate is expected to decline to between 7 and 7.5 percent by the end of 2012. In his testimony, Bernanke repeated the Fed’s pledge to maintain “exceptionally low levels of the federal funds rate for an extended period of time,” however, no new measures were offered to stimulate the economy. Fed Funds futures indicate no rate hikes from the central bank until August of 2011.

Weekly Update

ECB council member Jozef Makuch recently remarked that government bond purchases have diminished. Indeed, in the past week, the central bank bought a mere €302 million worth of bonds, down from nearly €1 billion last week and €4 billion in the week before that. Since the program began on May 10th, the European Central Bank has bought over €60 billion worth of bonds. ECB executive board member Juergen Stark has suggested that purchases may come to a halt if bond markets continued to improve. The yield on the Spanish 10-year bond, which has benefitted from the central banks’ purchases, has fallen to the lowest since early June, and is down nearly 70 basis points from the peak levels of one month ago. Turning to rate hikes, the general consensus of ECB officials is that the next hike will be sometime in 2011; markets foresee a single 25 basis point hike over the next twelve months.

Weekly Update

The minutes of the July Bank of England policy meeting were released on Wednesday: The central bank felt that prospects for GDP growth had “probably deteriorated a little over the month.” The bank went as far as to say “…the medium-term outlook for growth might have weakened too.” With regard to inflation, the BOE felt that “near-term prospects had worsened” and that “inflation is likely to remain above the target level for some time.” Nevertheless, the Committee’s central view remained that “the substantial margin of spare capacity [in the economy] was likely to persist for some time and would bear down on inflation over the medium term.” Based upon the minutes, the Bank of England is likely to maintain interest rates at current levels into next year, for upside risks to inflation are balanced by downside risks to the economy. Overnight index swaps suggest that there will be no rate hikes over the next year.

Weekly Update

The Bank of Canada raised the benchmark overnight interest rate 25 basis points to 0.75%, as was widely expected. The central bank sees the global economic recovery as “proceeding but not yet self-sustaining.” Given the weaker profile for global economic growth and the consequent impact on Canadian trade, the BOC downgraded its outlook for GDP growth to 3.5% in 2010, 2.9% in 2011, and 2.2% in 2012. Inflation is expected to be well-behaved near 2% throughout the projection period. The central bank believes that “considerable monetary stimulus remains in place” even after the latest rate hike, but “any further reduction of monetary policy stimulus would have to be weighed carefully against domestic and global economic developments.” Market interest rate expectations soared following the policy meeting, with 106 basis points of hikes expected over the next twelve months.

Weekly Update

Earlier this week Bank of Japan Deputy Governor Yamaguchi commented on recent developments. Yamaguchi says that the BOJ needs more time to assess the impact of the strong Yen on businesses, and that there may be an effect on exports. Though he declined to comment on intervention, many market participants believe that the BOJ may enter the market to weaken the Japanese currency, were it to strengthen further from here. That being said, the USD-Yen exchange rate remains close to 15-year lows.



Weekly Update

The Reserve Bank of New Zealand will meet next week to determine the fate of interest rates. In the last meeting, the central bank said that further rate hikes will be reviewed “in light of economic and financial market developments.” While there has been evidence that economies around the world may be experiencing a slowdown of some sorts, markets believe that the RBNZ will continue its rate hike campaign regardless. There is a high probability of a 25 basis point hike at the July 28th meeting. Furthermore, markets expect 128 basis points of rate hikes from the RBNZ over the next year.



Weekly Update

In the minutes to the July 6st meeting, the RBA noted that the global economy was expanding at about trend pace in recent months, “although the pattern of growth was uneven among regions…” Importantly, members of the board saw some moderation in Asian growth as “desirable.” According to the central bank, headline inflation was expected to rise due to “the effects of some tax increases, with the year-ended increase in the CPI rising above 3 percent.” The RBA believed that past rate hikes had afforded it the “flexibility to maintain steady settings in the face of increased international uncertainty.” Overnight index swaps indicate that there will be no rate hikes from the RBA over the next year.



Weekly Update

Over the past three weeks, the Euro-Franc exchange rate has showed some signs of life, as the pair finally arrested its precipitous decline to new record lows. The Swiss National Bank is surely satisfied by this development. Nevertheless, the Franc probably remains stronger than the SNB would like, and thus the probability of any rate hikes in the near-term is close to zero. Markets are expecting no rate hikes from the SNB over the next year.



For a summary of past rate decisions, see our Central Bank Interest Rate Outlook

Written by: Sumit Roy, DailyFX Research
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