~~ Bernanke vs Trichet ~~
Bernanke/Trichet- The Heavy Weight Title "Ready to Rumble"
Analysis by NewsTraderFX
By TheLFB.com, Today 10:32pm, Topic Market Insights
This was the week financial markets and the dollar were bit players in a mythological battle royale between the Federal Reserve and the European Central Bank for the Heavyweight Championship of the World. Before getting into specifics, we would like to summarize the immediate implications for currency traders:
It’s likely to see a continuation of the rhetoric in the coming days and weeks, which means more than ever, price will be fundamentally driven back and forth as statements are released. Therefore, we believe it unlikely that any clear trends will be established until such time as a more unified view on the direction for interest rates is more fully established.
Round One: Bernanke vs. Trichet
Bernanke Swings First But Leaves Himself Open
In an extraordinary step taken during a speech on Tuesday, Fed Chairman Bernanke commented directly on currency by saying, "the Fed’s aggressive rate-cutting campaign has contributed to a lower value of the U.S. dollar. That, in turn, has helped to push up the prices for imported goods flowing into the United States, such as oil, and fueled a rise in consumer prices. Bernanke called that development "unwelcome," and added the Fed is "attentive to the implications of changes in the value of the dollar for inflation and inflation expectations."
Bernanke’s comments helped drive the dollar to it’s best levels against the euro for weeks, and pushed oil nearly $15/bbl below the the recent high. Bernanke did not signal an increase, but rather implied rates would remain on hold by saying they were "well positioned" for growth and stable prices. His mistake was to leave himself wide open for an ECB counter punch by indicating that the risks to growth will be to the downside, from the housing market and oil prices particularly. The Fed’s view is that consumer spending has so far "held up a bit better than expected," but that they face "significant headwinds" from falling home prices, a softer job market and tighter credit.
Leaving his chin fully exposed by noting that headline inflation has remained high because of food and energy prices, Bernanke went on to say that "the pass-through of high raw materials costs to domestic labor costs and the prices of most other products has been limited, in part because of the softening of domestic demand." If commodity prices just level out, even at high levels, that "would result in a relatively rapid moderation of inflation," and that is what he and other Fed officials are expecting.
Trichet Counter punches
Trichet landed his first jab at the ECB press conference on Thursday. The European Central Bank President said the bank was monitoring inflation with "heightened alertness” as oil and food prices increase, toughening the ECB’s interest-rate stance. "We noted that risks to price stability over the medium term have increased further,” said Trichet at a press conference in Frankfurt after the ECB left its benchmark rate at 4 percent. "It is our strong determination to secure a firm anchoring of medium to long-term inflation expectations.”
However, it was during the question and answer period which followed Mr. Trichet’s opening remarks where the big blow was landed when the ECB president responded to a question by saying that, "after having carefully examined the situation, that we could decide to move our rates by a small amount at our next meeting,” adding that "I don’t say it’s certain. I said it’s possible.”
Judges Decision: Bernanke Staggered, Round One Goes To Mr. Trichet
By the close of trading on Friday, the dollar had declined 2.5% against the euro and oil had gained 12.2%. Between rounds, Bernanke was seen panting on his stool while his seconds worked on a mouse below his left eye. Trichet refused to sit down between rounds, preferring to stare angrily at his weakened opponent across the ring.
Going Forward
Bernanke has apparently made a huge mistake by implying rates will remain on hold and maintaining a growth bias. Now that Mr. Trichet has laid down the gauntlet, neutrality on rates will apparently not be enough to control the oil inflation. The Fed will need to switch fairly quickly to an oil-shock related inflation bias, as it’s apparent that oil has disconnected from its fundamentals and is free-floating upwards on the back of the weak USD without an apparent ceiling.
The Fed needs to maintain its inflation-fighting credibility in the market, because inflation is now a greater threat to the economy than is growth. If the bias is not switched quickly and rates are not increased at least by the end of the year, it risks repeating the same mistakes as the 1970’s when rate were increased too slowly as oil spiked. The failure to tighten policy fast enough necessitated the drastic increases by then-Fed Chaiman Paul Volker and subsequent severe early 1980’s recession.
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