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Forex Trading | Brokers | Forex Trading Platforms (20100) / About BondsForex Trading Brokers, Fund Managers, Forex Trading platforms, articles and a FX trading communityHome Analysis
A Bodyguard of Lies
03-03-2008 - FX Solutions | Fundamental
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Market Directions Monday, March 3, 2008
Federal Reserve Vice Chairman Donald Kohn s speech on
Wednesday broke the stalemate between the dollar and the euro.
Warning that slower economic growth is a greater
threat than inflation, Mr. Kohn helped turn a stop driven
run through 1.5000 in the Australian market into a full fledged
paradigm shift. And when he was seconded by Federal Reserve
Chairman Ben Bernanke s gloomy Congressional testimony that
the economic situation had become distinctly less favorable and
that the Fed will act in a timely manner as needed
the speculation for Fed rate cuts beyond the March 18th meeting
moved into high gear. The futures market now expects a 2.00% Fed
Funds target rate by May Day; a 65 basis point reduction at the
March 18th FOMC meeting and another 30 points by the end of April.
It would be easy but inaccurate to blame the Fed Chairman and Vice
Chairman for the dollar s collapse. But it would be accurate
to say that that they and the Fed governors have done little to
temper the dollar decline brought on by their policies. The Fed has
not so much talked the dollar down as refused to provide rhetorical
support. To be fair official dollar policy is not the purview of
the Fed but belongs to the Treasury Department headed by Hank
Paulson, the former CEO of Goldman Sachs. But in the current
economic environment Mr. Bernanke has been the chief spokesman for
economic policy and his omissions do not jibe with the standard US
strong dollar policy as reiterated by President Bush and Secretary
Paulson. When the Fed Chairman says the obvious, that a weak dollar
fosters US exports, currency traders hear not the description of a
currently weak dollar but a prescription for a much weaker dollar
in the future.
Mr. Bernanke s has long said that the economic facts will
dictate Fed policy and he has been uncommonly open in discussing
the statistics and methods that the Fed uses to arrive at policy.
But his transparency on Fed rate policy ties that policy very
tightly to those statistics. Traders know the economic facts, none
better. US economic statistics on GDP, business planning,
employment, consumer sentiment and inflation are full of distress.
If the economy is not in outright recession the signs are not
pointing in any other direction. But traders no longer have to wait
for Fed pronouncements to ascertain its next policy move they only
have to read the economic tea leaves.
Any economic policy can have can have both desirable and
undesirable elements. Lower American interest rates are a current
necessity for the US economy and financial system. But lower rates
devalue the dollar, exacerbate inflation, strain international
economic relations, contribute to commodity price inflation and
generally undermine the stability of the world financial system.
For a central banker, a rapidly devaluing reserve currency is
something to be avoided if at all possible. The dollar has
depreciated more than 13% against the euro in six months. But at no
point in that decline has the Fed spoken convincingly in defense of
the US currency. Why
Central bankers often use rhetoric to ameliorate the undesirable
effects of a policy or to push the markets in a direction without
employing the bludgeon of interest rate policy. Hectoring the
markets can be quite effective in the short term.
However, the policy transparency of the Bernanke Fed has worked to
limit the effectiveness of its rhetoric. Currency traders can read
economic data almost as well as the Fed, but because Mr. Bernanke
has so carefully delineated the logic and evidence behind its
decisions they no longer need to wait for the Fed, nor are they
checked by doubts as to what that decision will be. Speculative
positioning is given a freer rein. Mr. Bernanke has not sought to
check the market with rhetoric. Granted, it would not be logical to
reduce interest rates and then warn the market that inflation was
still a major concern. It would not be logical. But if the goal was
to temper the decline of the dollar, it would be effective.
Contrast the Fed policy with that of the European Central Bank
under Jean Claude Trichet. At the last ECB meeting the bank s
official statement and pronouncements were universally interpreted
to mean that the bank had moved to a neutral rate stance. The euro
promptly fell. Worsening economic conditions in the US, if not yet
in Europe, would, it was assumed prevent the ECB from raising rates
even if inflation accelerated. The ECB neutrality was an
acknowledgement of that fact. But a strong euro is a hedge against
the ECB s main concern -- inflation. In addition, European
unions are demanding hefty wage increases which are the primary
second round inflation effects the bank is trying to prevent. The
central bank does not want a sinking euro to complicate its
anti-inflation fight. So the ECB immediately turned up the
rhetorical heat. Mr. Trichet, Axel Weber and other governing
council members were repeatedly quoted in the media warning of
inflation and stressing the bank s determination to prevent
the ascent of inflationary expectations. The euro returned to the
middle of its range against the dollar. It was not logical but it
was effective.
The Bernanke transparency on Fed rate policy has had the perverse
effect of limiting the Fed s options. Because Mr. Bernanke
has so carefully outlined the logic of Fed policy and the
statistics that it watches and because he has so carefully kept to
his open precepts the chairman cannot credibly gainsay the
statistics or the Fed policy with rhetoric. He cannot do what the
ECB did, adopt a neutral rate stance one week and then deny that it
had done so the next.
Mr. Bernanke s acknowledgement before Congress and a thousand
trading room televisions that a weaker dollar bolsters US exports
may be true, but it is not helpful. It only worsens the dollar
decline. Unless a lower dollar is the Fed s goal, such talk
it is counterproductive. A little doubt about the Fed s
intentions could go a long way right now. Doing one thing and
saying another is probably just what the dollar needs. Mr. Trichet
seems to know this, Mr. Bernanke does not. To quote Winston
Churchill, In wartime truth is so precious that she should
always be attended by a bodyguard of lies . The dollar could
use such a guardian.
Joseph Trevisani FX Solutions Chief Market Analyst
Joe@fxsol.com Content Provided by:
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