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US Dollar Rallies on Fed Warning - What Can We Expect from Bernanke in Months to Come?

Friday, 31 August 2007 16:50:52 GMT  |  David Rodriguez, Currency Analyst

The US dollar rallied on speeches from Fed Chairman Ben Bernanke and President George W. Bush, as neither government official was able to soothe market concerns over the future of the domestic credit crunch and subprime housing risks. The much-anticipated speech by the Fed’s Bernanke told markets that the Fed remains receptive to fresh economic data and stands ready to react to slowing economic growth. Yet the monetary policy official made it explicitly clear that the US central bank was not willing to bail out “speculators” with monetary policy accommodation. A similar tone from the US President fell short of market hopes for a large-scale intervention in mortgage and credit market troubles.

The Euro lost significant ground against its American counterpart in the wake of the earlier Fed speech, shedding $.0070 off of intraday highs to $1.3637. The British Pound was similarly weak on speculators’ disappointment, losing $.0130 to lows of $2.0107.  Meanwhile, the Japanese Yen was the biggest gainer on the day; the US dollar fell ¥1.13 off its highs to ¥115.47.

Markets remained relatively unaffected on fresh economic data, instead waiting for the critical Fed speech and words from President the US President. Bernanke spoke at an annual monetary policy conference in Jackson Hole, Wyoming, discussing the Fed’s stance on recent market troubles and subsequent policy responses. The central banker made it explicitly clear that the FOMC would not stand in to shield speculators from adverse market conditions, stating: “It is not the responsibility of the Federal Reserve—nor would it be appropriate—to protect lenders and investors from the consequences of their financial decisions. But developments in financial markets can have broad economic effects felt by many outside the markets, and the Federal Reserve must take those effects into account when determining policy.” 

The Fed Chairman said little to explicitly address interest rate expectations, but his clear warning to the investment community dashed market hopes for aggressive monetary policy accommodation in response to the recent credit crunch. Yet Bernanke likewise made it clear that the Fed will act swiftly to counteract any market spillover into broader domestic economic growth—leaving currencies and other assets incredibly dependent on future US economic data. He emphasized that recent fundamental data was of little consequence to monetary policy considerations, however, as delayed figures give no indication to how the economy has responded to duress in financial markets. The Fed Chairman was very frank in his overall assessment of the economy and justifications behind monetary policy decisions, but it remained clear that markets are still hesitant on what to expect from the FOMC through the coming months of policy meetings.

Morning economic data likewise did little to shift market expectations for the future of US interest rates, with Personal Income, Spending, and PCE Deflator figures falling broadly in line with consensus forecasts. Both spending and incomes grew at their fastest pace since March, with the national savings rate accelerating through the same period. Such positive signs of growth may prove transitory, however, as late-July and August credit market turmoil may make it significantly more expensive to fund future spending growth. Increased home mortgage interest payments will single-handedly hurt household purchasing power and almost certainly slowdown the very recent pickup in consumption. Given fast-dropping consumer confidence, it will likely only be a matter of time before Personal Income and Spending figures reflect recent market troubles.  

Domestic stock markets nonetheless rallied into the afternoon, buoyed by hopes that Federal initiatives to stem homeowner mortgage defaults would ease the effects of a widespread housing recession. The Dow Jones Industrial Average continued its recently volatile trade, gaining 182 points to 13,421. The S&P 500 was the largest percentage gainer at +1.5 percent to 1,480. Tech stocks were slowest to advance, with the NASDAQ Composite 1.2 percent improved to 2,596.  

Renewed equity rallies were enough to cut back recent US Treasury Bond gains, with the 2-year note gaining 6 basis points in yield to 4.17 percent. Longer-dated debt was similarly offered through the afternoon, with the 10-Year losing 5/16 points to 101 and 5/8. Yields on the 10-year added 4 basis points to 4.55 percent.  

Written by David Rodriguez, Currency Analyst for DailyFX.com

 

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