Fed remains on course?

Bernanke and Co. do not want to ‘rock the boat’. With inflation concerns, policy makers have little interest in adjusting rates anytime soon (2.00%), hence the somewhat less hawkish statement from them yesterday. Both the US$ and equities win, but, until when?

The US$ is stronger in the O/N trading session. Currently it is higher against 10 of the 16 most actively traded currencies in a ‘subdued’ trading range after the Fed rate announcement yesterday afternoon.

There were no surprises in the Fed’s decision. Bernanke and company kept its benchmark O/N rates at 2% and signaled that ‘weak employment and financial instability will delay any increase in borrowing costs in the foreseeable future’. The following communiqué highlighted that ‘tight credit conditions, the ongoing housing contraction, and elevated energy prices are likely to weigh on economic growth’ (recent data confirms this). But, policy-makers do expect inflation to slow on the one hand, while on the other acknowledge that the outlook for prices is ‘highly uncertain’. This has futures traders paring a rate expectation hike by year end. Most capital market participants believe that the next move will be an increase, but perhaps not until early next year. The dovish feeling may be reiterated by both the ECB and BOE tomorrow. Global economies have now become entrenched in a slowdown phenomenon, which will likely persist for sometime.

The summer of woes for Cable continues (1.9531). The pound remains under pressure after Nationwide Bank in a private industry survey indicated that UK consumer confidence printed a new 4-year low (51 vs. 62) last month as house prices tumble. Analysts believe that stronger evidence of late, showing that the UK is heading into a recession will handcuff BOE policy-makers tomorrow, where it’s anticipated that they will keep rates unchanged (5.00%) despite inflationary pressures. Expect investors to remain better sellers of STG on rallies.

The US$ currently is lower against the EUR +0.13% and CHF +0.20% and higher against GBP -0.10% and JPY -0.07%. The commodity currencies are weaker this morning, CAD -0.04% and AUD -0.16%. Amazing what a year does, the loonie has nearly reached its yearly lows as commodity prices tumble and the US$ gains ground across the board. The double whammy has most commodity currencies printing medium term lows. Commodities account for 50% of Canada’s exports and nearly 75% of total exports head south of their border. Economic data has been on the softer side of late, coupled with a benign inflation rate and slowing US economy, analysts have been anticipating that the BOC would have to ease rates further (3.00%) some time soon. With the Fed remaining hawkish about inflation, the possibility of the Fed hiking rates over the past month has hindered the loonie strength (interest rate differential). So far this year the loonie has lost nearly 5% vs. the greenback as precious metals and oil retreat. One can expect the CAD$ to remain under pressure in the short term, as investors continue to be better buyers on pull backs.

The AUD$ remains under pressure and printed 4-month lows yesterday (0.9148) as traders speculate that slower economic growth and benign inflation numbers will convince the RBA to cut interest rate sooner rather than later (7.25%). Hence, investor’s appetite for Aussi bonds has yield advantage narrowing vs. US treasuries. With commodity prices under constant pressure, short term selling of the AUD$ remains the name of the game.

Crude is higher O/N ($119.55 up +38c). Crude remains on a downward spiral as investors become concerned about future demand amid signs that a slowdown in the US and European economies take a firmer grip. Weather related concerns also fuelled price easing yesterday, the storm Edouard was downgraded to a tropical depression over Texas. Economic data this week has pointed to a global slowdown, the services sectors in the US and UK contracted last month while European retail sales fell the most in a dozen years. Demand numbers remain weak in the US due to elevated gas prices, it will be know as the summer when the motorist spoke with their wallet and stayed away from the gas pumps. Thus, traders are speculating that high prices and slower US economic growth will further reduce demand in the US (the world’s largest consumer) and hence oil prices. Despite the Fed keeping rates on hold (2.00%) they remain very concerned with inflation whose biggest component has been both fuel and food. Technical support levels are under threat now that future prices have penetrated the $120 level. Is this sustainable? Will other geopolitical and weather concerns provide a bid? In less than three weeks oil has lost nearly $30 of insurance premium. Traders will get a better feel with today’s inventory numbers. Gold remains under pressure ($892) as the greenback advances and falling energy costs reduced the appeal of the ‘yellow metal’ as a hedge against inflation.

The Nikkei closed at 13,254 up +340. The DAX index in Europe was at 6,553 up +33; the FTSE (UK) currently is 5,488 up +33. The early call for the open of key US indices is mixed. Yields of the US 10-year backed up 4bp yesterday (4.00%) and are little changed O/N. Treasuries prices have eased as traders cheapen up the curve once again ahead of 10 and 30-year government product hitting the streets over the next few days ($17b and $10b respectively). Investors continue to remain concerned that the Fed may not be able to contain inflation despite the US economy slowing.

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