All Bernanke, All the Time

It’s Wednesday and Benny the Beard
Does desperately want to be cheered
By all the bond players
As well as soothsayers
But fears that instead he’ll be jeered

“Policy makers have been very careful in the U.S. to point out the distinction between monetary policy and bond-buying,” said Anshu Jain, co-CEO of Deutsche Bank AG. Once again I claim that this is a distinction without difference. The Fed initiated its QE policy only because it had run out of room to cut interest rates further, its traditional (and preferred) monetary policy channel. If it felt that negative short-term rates were viable, it would have continued down that road and not expanded its balance sheet as dramatically as it has. However, to claim that bond-buying by the Fed is not monetary policy is either willfully ignorant or a blatant lie. I am pretty sure that Anshu Jain understands this, but as with so many public figures, he is unwilling to allow the plain meaning of the words to stand for themselves because of the uncomfortable truth behind them. Thus all the market spin. As Chairman Ben heads to Capitol Hill today to testify to Congress, all eyes will be on what he has to say (which will be available at 8:30 this morning) and on his responses in the Q&A. He has a tough job trying to explain why his monetary policy actions are not monetary policy. Of course, the reason we care is because he is the single biggest influence on markets right now, so depending on the tone of the testimony, we will get different market responses.

“Bernanke today may also renew calls on lawmakers to avoid sharp short-term spending cuts, which he has said could harm the economy in the near term, while adopting a plan to lower long-term fiscal deficits,” according to Bloomberg News. This statement in a Bloomberg article this morning highlights one of the key problems the US has faced. For economists it is quite simple, promise to cut spending in the future but don’t do it now because it will have negative ramifications for the economy. Ultimately, the issue with this is that those long-term promises are never fulfilled, hence the ever expanding debt ratios. All the deficit hawks (myself included) are tired of the empty promises and are willing to suffer somewhat slower growth now in order to address the long-term problems. But most politicians are simple, self-serving hacks who care only about being reelected and they believe that if they stop giving away other people’s money to their constituents, they won’t be reelected. Hence, they will never, willingly, cut spending. This is the crux of the fiscal problem in the US (and elsewhere) and it is unlikely to be addressed by the current Senate or Administration. The House, to its credit, has tried to do so.  This also helps define the underlying fiscal condition in the US, which is a key part of market fundamentals.

So the question is, how will all this impact the FX markets? My sense is that the market has begun to embrace the idea that a reduction in bond buying is not a tightening of policy. I’m not sure why, but I guess if Bernanke says it frequently enough, people will eventually believe it. This has moved into the realm of propaganda, a dangerous outcome in my view. However, he may well be successful at convincing the masses that ending QE is not tighter policy and if so, I would expect the dollar to suffer. Remember, the dollar’s performance against most currencies of late has been largely predicated on the idea that the Fed had moved closer to the end of easing policy while the ECB, BOE and BOJ were all just getting started. However, if Bernanke is successful, we probably have some further dollar weakness ahead. This is especially true in both the euro and the pound, but I think the yen story has another feature, this weekend’s election for the Upper House of the Diet.

In the Eurozone, despite an increase in the visibility of problems in Greece, Portugal, Spain, Italy and France, buyers continue to appear. Draghi has been successful in virtually eliminating the existential threat to the single currency through his verbal intervention, and it seems reserve buyers are very willing to continue diversifying their USD holdings into EUR. Despite an ongoing recession across the entire continent, that shows no signs of ending, and promises of a long period of extremely low interest rates, the euro has held its own. If Bernanke convinces the market that he is not tightening policy, then the euro will test 1.35. It doesn’t make sense to me, but that seems to be the reality.

In the UK, today’s minutes of the July 4 MPC meeting showed a surprising 9-0 vote in favor of leaving the British QE amount unchanged as new Governor Carney was able to convince his colleagues that verbal intervention would be more effective, with less actual financial consequences. Today’s labor data from the UK underscored that unlike the Eurozone, the UK economy has brighter near term prospects. While the Unemployment Rate was unchanged at 7.8% (Europe’s is 12.4%), the Claimant Count fell a much greater than expected 21.2K, meaning that many fewer Brits were unemployed. This is analogous to our Initial Claims data. The pound has benefitted from the combination of both the MPC minutes and the data and has rallied here to its highest level in 2 weeks and looks very much like it has bottomed for now. I thought that the pound was headed toward 1.40, or at least 1.45, but if we do get there, it will take quite a while. At this point, I expect it to range trade between 1.50 and 1.55 for the next several weeks at least, and depending on what happens in the US, maybe longer.

In Japan, things are a bit different as there has been no indication of any policy change on the monetary side, but more importantly, the election this weekend will define exactly what kind of mandate PM Abe has to exploit. If he carries the Upper House, as currently expected, then the LDP will control all the policy levers and I believe will be more aggressive on the Fiscal/Regulatory side of things. I also believe that a big victory this weekend will result in a much weaker yen, perhaps a test of the 103 level, as traders anticipate the next leg of success in Abe-nomics.

Finally, emerging market currencies may be dramatically impacted by Bernanke as their recent weakness has been directly attributable to the idea of the US slowly tightening policy. If that idea is changed by today’s testimony, I expect that we will see these currencies, on the whole, recoup some of their recent losses. Slowing global growth remains a problem for them, especially the situation in China, but if there is a limited prospect for higher US rates, yield hounds will be back buying these currencies.

On the data front, yesterday’s CPI showed a greater than expected increase and may start to open the eyes of the FOMC, but we will need more of the same for it to have any real impact. Today we get Housing Starts (exp 960K) and Building Permits (1.0M) which will indicate if the recent rise in mortgage rates has had any substantive impact on the housing market, which has been a key driver in the US’s recent positive economic performance. But in the end, its all Bernanke all the time.

Good luck