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Dollar Extends Slide as We Inch Closer to a Pause

Thursday, 20 July 2006 21:45:16 GMT  |  Kathy Lien, Chief Currency Strategist

Bernanke stuck to his guns at his second back to back testimony on the economy and monetary policy.  Despite pressure to elaborate on the messages that he has been sending, Bernanke reiterated his toned down comments and left the market still guessing on whether we will see another interest rate hike in August.  The minutes from the June 28-29 FOMC meeting were equally subdued.  Confirming how close the Fed is to pausing on interest rates, the minutes indicated that the decision to raise interest rates at the last meeting was a “close call.”  Furthermore, many of the FOMC members warned about the difficulties in terms of what to do next with monetary policy.  According to former FOMC member McTeer, “normally, its fairly clear.”  The fact that it is “uncertain” this time suggests that the Fed may really be concerned about the risks that lie ahead. At this point, the futures market is pricing in a less than 50 percent probability of an August rate hike.  The odds have fallen significantly since the stronger inflation numbers that we saw on Monday and Tuesday.  Today’s weaker economic reports provide additional evidence of the biggest risk, which is that an overly aggressive Fed could cripple the US economy.  This may be a bit dramatic, but a meaningful slowdown is not.  Everyone from bank analysts to interest rate traders are pricing in much weaker conditions in 2007.  Leading indicators have already grown at a slower pace in the month of June following two straight months of negative readings.  Meanwhile the Philadelphia Fed survey took a sharp plunge from 13.1 to 6.0, the lowest reading since January.  Although a positive reading still indicates growth, the combination of today’s weakness along with a big drop in the Empire State survey reported on Monday suggests that we could see an equally meaningful drop in the ISM report for the same month.  There was one piece of good news that came out, namely jobless claims, which shrank from 334k to 304k.  Claims continue to be at very encouraging levels and indicate that for the time, even though the economic outlook is uncertain, companies have yet to institute any major layoffs, which should keep consumer spending stable. 

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