Bernanke:Can he ‘switch hit’?

Bernanke and Co. believe they have the tourniquet, but they cannot stop the bleeding. A ‘Sea of red’ prevails across most asset classes as investors are panicking, with good reasons of course. Once the lemmings begin their journey, it is difficult to dissuade a mob mentality in the short term.

The USD$ is weaker in the O/N trading session. Currently it is lower against 13 of the 16 most actively traded currencies in a ‘whippy’ trading range as the USD$ liquidation crisis continues.

The US consumer is still breathing, but only just. US retail sales advanced less than expected yesterday (+0.1% vs. +0.8% m/m). Recent federal tax rebates have not lifted sales as much as had been expected, which does not bode well for the economy. Digging deeper, the main culprit was motor vehicle sales, which declined -3.3%, otherwise we would have had a +0.8% print. A +4.6% jump in gas stations provided the gain in the final number (ex-gas fell -0.5%). Analysts note that removing both components leaves us with an anemic +0.2% gain. The go to variable for the Fed, the consumer, is closing up shop and is forced to pare their spending habits due to higher food and fuel pricing. Couple this with tighter lending restrictions and lower housing prices can only affect the consumer even further. Expect the Fed’s back to remain against the wall as further financial write downs and ongoing weakness in the financial markets to force the Fed to cut rates even further this year (2.00%) as liquidity concerns prevail.

The Fed will be thankful that commodities, which are lifting US producer prices, are not getting passed on (yet!). The headline number looks bleak (+1.8% vs. +1.4%), but, the report shows that core-producer price inflation remains muted (+0.2%). The number remains the same m/m, the weakest rate of increase this year. But thankfully, a weak core signals even weaker than expected pass through of food and energy prices into the broader economy. This will provide the strongest evidence for the Fed that they can shift their main policy focus of inflation back to liquidity and housing.

Again yesterday while testifying to the Senate Banking Committee, Fed Chairman Bernanke said ‘risks to both US growth and inflation have increased’, thus abandoning last months assessment that threats to the expansion had ‘diminished somewhat’. His shift reflects renewed turmoil in markets that has forced policy makers to sort out the ailing GSE’s (one of many institutions). Not inflation, but stabilizing financial markets remains ‘a top priority’. Many financial firms he described are ‘under-stress’. He sees virtually nothing positive in the real sector other than export and inventories. Consumption is now expected to be restrained well into next year; business investment to be cautious and housing remains weak. Inflation is expected to rise in the near term in part because of the weakness in the USD$ and rise in import prices, but moderate in 2009.

The US $ currently is lower against the EUR +0.12%, JPY +0.62%, CHF +0.21% and higher against GBP -0.04%. The commodity currencies are weaker this morning, CAD -0.13% and AUD -0.10%. The loonie traded at a premium to its southern neighbor yesterday, the first time in nearly two months on concern that widening credit-market losses will drag the US economy into a deeper recession. Bernanke dealing with stagflation and financial turmoil continues to see mass exiting of global USD$ positioning. But, expect traders to be weary of Bernanke’s comments that growth issues in the US will affect both oil and gas prices. By default, it will eventually have a negative effect on the CAD$ who’s exports account for 50% of commodity products. As anticipated, the BOC left rates on hold at 3.00% and governor Carney indicated that economic risks are ‘balanced’ between inflation and economic growth. They expects higher than expected headline inflation over the next year, but also noted that core-inflation to remain ‘well contained’. Futures traders continue to price in no rate changes for the remainder of the year. The communiqué was less hawkish than expected. Thus, in the short term one can expect the currency to be influenced by what ever happens in the US. If investors continue to abide by risk aversion trades, by default, the loonies will be pushed higher as the USD$ under performs against most of its main trading partners.

The AUD$ fell from its 25-year high after RBA Governor Stevens signaled that interest rates (7.25%) may be high enough to keep inflation in check (0.9775).

Crude is higher O/N ($138.65 down -10c). Geo-political concerns and inventory levels had boosted crude prices all week until Bernanke indicated yesterday that a slower US economy will curtail demand for oil and gas. The market is starting to factor a ‘deeper recession’ taking a firm grip and by default unsettling future demand. G8 and OPEC ministers in the past have tried to knock crude prices with their rhetoric. But, it seems with the above prediction coming straight from ‘the horse’s mouth’ (Bernanke), finally has persuaded the speculator to offload some of the elevated futures. With global equities under constant threat, growth and demand can only be negative. Other geo-political factors will of course remain on the backburner and act as a stop gap for plummeting prices some where. Brazil’s state controlled oil company (Petroleo Brasileiro), has begun a 5-day labor action in a specific region that supplies 82% of their output (+1.8m barrels), combined with the Nigerian delta unrest, will continues to provide a safe net for prices eventually. Besides the Israeli and Iran issue cannot disappear overnight. This morning traders expect a greater drawdown on inventories. Bring on the weekly EIA report and see what happens. Gold remains better bid ($979) due to plummeting equities and a flight to quality mentality increasing demand for the yellow metal as a safer heaven.

The Nikkei closed at 12,760 up +6. The DAX index in Europe was at 6,087 up +5; the FTSE (UK) currently is 5,157 down -15. The early call for the open of key US indices is higher. Yields of the US 10-year bond eased 3bp yesterday (3.82%) and are little changed O/N. Treasury prices continue their rampant rally, especially in the short end, with Bernanke saying there are ‘significant downside risks’ to economic growth. The US yield curve has steepened to 146. With the equity markets finding it difficult to make any head way, fear will continue to drive investors towards the FI asset class for surety reasons.

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