THE IMPORTANCE OF BERNANKE’S TESTIMONY
Fed chairman Ben Bernanke’s testimony to Congress will be important in setting the tone for the markets (particularly the dollar, equities and US treasuries), as traders hunt for clues on when the Fed is likely to ease its rate of asset purchases.
The greenback surged last week, with the dollar index reaching a three-year high, on the back of traders’ expectations that improving US economic data will lead the Fed to begin tapering its programme of quantitative easing, possibly as early as the middle of this year.
Minutes from the FOMC’s latest policy meeting in May will follow Bernanke’s testimony. However, it is likely that Bernanke’s testimony may take the edge off this release, in terms of market impact.
FOMC POLICYMAKER UNCERTAINTY
Bernanke’s testimony is crucial, given the mixed messages from Fed officials in recent weeks. For example, Charles Plosser has suggested decelerating the rate of asset purchases, also suggesting that the Fed shortens the duration of the bonds it currently holds.
Some FOMC members, like John Williams, are in favour of tapering asset purchases by the end of this year. On the other hand, Eric Rosengren has argued that now is not the time for the Fed to taper its asset purchases.
And this week, Richard Fisher came out in favour of slowing purchases of mortgage securities, saying the housing sector no longer needs the Fed’s support.
Sebastien Galy, an analyst at Societe Generale, says “the Fed is slowly moving out of the ultra-dovish camp, as the Bernanke clan reassesses the risks for the Fed balance sheet and the economy of ultra-easy conditions for so long.”
It appears as though the Fed is eager to push the debate into the public domain. Simon Smith, an economist at FxPro says that “[the Fed] is keen not to scare markets when the [tapering] does eventually happen, hence the propensity to talk openly about it.”
WHAT CAN WE EXPECT?
What is definitely known is that the Fed is intent on tapering asset purchases. When is less clear – it is generally accepted that it could be anytime from the middle of this year, all the way out to 2015 (assuming that the tone of economic data improves – especially unemployment and inflation).
However, it is worth noting that “the current debate over tapering QE does not stem from a satisfaction with state of the labour market or concern over inflation risks but a desire to limit the perceived financial stability costs of QE,” according to Divyang Shah, a strategist at IFR Markets.
Recent US economic data has softened, but is still encouraging. Retail sales notably beat expectations, rising by 0.1% in March. Consumer confidence has improved; the University of Michigan consumer sentiment index advanced to 83.7 in May, from 76.4 in aPRIL, as the mighty US consumer shakes off the impact of fiscal sequestration.
But challenges on the supply-side of the economy remain, as shown by both the Philly Fed and Empire State manufacturing surveys, which both fell below 0; industrial production also shrank by 0.5% in April. And the employment situation is mixed, with weekly jobless claims inching higher last week, after improving over the preceding weeks.
Nevertheless, Mansoor Mohi-uddin, an FX strategist at UBS, believes that there is still positive underlying growth momentum, pointing to the Philly Fed survey’s inventories sub-index, which rose from -26.3 to 0.7. And although housing starts fell by 16.5% in April, the forward-looking measure of building permits jumped by 14.3% month-on-month.
But Mohi-uddin believes that “it is still too early to expect the Fed to [taper asset purchases] in the summer.” This line of reasoning is underscored by the benign inflation outlook in the US. Core inflation – as measured by Private Consumption Expenditure, which is the Fed’s preferred gauge of inflation – has eased to 1.1% on an annualised basis.
A recent article in the Wall Street Journal by Jon Hilsenrath, a prominent Fed watcher, suggested that FOMC members are not alarmed by the deflation risks, and are satisfied that inflation expectations are stable. Traders consider the benign outlook as supportive of continued monetary stimulus. FxPro’s Smith reasons that “it seems unlikely that the Fed will step back from its commitment to buy $85 billion of securities per month in the near-term, with the economy still mixed and inflation pressures easing.”
Whether or not Bernanke will choose to communicate his personal views on when asset purchases will be tapered remains to be seen. Some speculate that any change to the Fed’s asset purchases will only come when Bernanke holds a press conference after the policy meeting, which would give him an opportunity to fully explain the FOMC’s rationale.
These press conferences are usually held in March, June, September and December, when the Fed also updates its economic forecasts. Mohi-uddin thinks that “June seems too early, while September and December seem more likely for the Fed to start reducing its pace of easing if the US economy re-accelerates.”
But staying focused on Bernanke’s testimony on Wednesday, Kathleen Brooks, research Director at Forex.com, says that there are two key questions that traders want answers to: “How will he explain the uptick in initial jobless claims last week? How will he react to the drop in core inflation to a two-year low at 1.7% for April? His answers to these potential questions from Congress could determine the medium-term outlook for the buck.”