Bernanke Joins the Doubters - 11th August, Forex Update

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by: fxsolutions
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Date: Thu, 25 Aug 2011 Time: 7:20 AM
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Joseph Trevisani, Chief Market Analyst at leading online Forex trading broker FX Solutions (http://www.fxsolutions.com/), provides an overview of currency market activity and news for 11th August 2011, including an analysis of Tuesday's FOMC statement.

"The real message of Tuesday's FOMC statement was not in its promise to keep the Fed Funds rate where it is for the next two years. The Fed promise is conditional. If in eighteen months the economy is recovering and inflation is headed higher, the FOMC will certainly move on rates.

The crux of the Fed's analysis is that it has joined the economic doubters. The Open Market Committee no longer believes that the US economy is in or on the verge of a slowly strengthening recovery. Its own optimistic assessment from the early part of the year been dissolved by the stagnant growth in the first half of the year and the steady decline in almost every forward looking indicator since then. It appears that the Fed was as surprised by the negative revision of GDP growth in the first half of the year as the rest of the market.

The FOMC statement begins by acknowledging the inaccuracy of its prior judgment. The June 22nd statement said "the economic recovery is continuing at moderate pace…" Yesterday's comment was "economic growth so far this year has been considerably slower than the Committee had expected".

A labor market that was "weaker than anticipated" in June has seen further "deterioration in…market conditions in recent months and the unemployment rate has moved up". Except for business investment in equipment and software expenditures, activity in other categories has either fallen, household spending is now flat as opposed to expanding, or remains moribund as "investment in nonresidential structures is weak and the housing sector remains depressed". The temporary negative factors from the June analysis, higher food and energy prices and the supply disruptions from the Japanese earthquake, are now only partially responsible for the "recent weakness in economic activity".

In June the Committee expected "the pace of recovery to pick up over coming quarters and the unemployment rate to resume it gradual decline…" There were no downside risks to the recovery and inflation was forecast to drop to levels "consistent with the committee's dual mandate…" The change in Tuesday's statement could not be more striking. "Moreover, downside risks to the economic outlook have increased."

"The committee also anticipates that inflation will settle, over the coming quarters at levels at or below those consistent with the Committee's dual mandate…as the effects of past energy and other commodity prices increase dissipate further". When the Fed says inflation is too low, it means deflation.

In late 2008 and 2009 the central bank was very worried that the economy might enter a deflationary spiral. In deflation falling prices reinforced by collapsing demand prompt consumers to put off purchases anticipating future lower prices, which in turn further depresses production, jobs, wages and prices.

The Fed probably did not have to underline its deflation warning by making the unprecedented promise to keeps the Fed funds rate at a historical low for two more years. In trading earlier today the two year and ten year Treasuries touched all time low yields. There is little doubt the bond market would have gotten the message without the promise. But it is a measure of the Fed's concern that it was not taking any chances."

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