Speech from Bernanke on Nov. 29

We see a fairly neutral stance from the Fed president. A close eye will be kept on future macroeconomic references until December 11 meeting.

Excerpt from Bernanke's speech...

With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

Core inflation--that is, inflation excluding the relatively more volatile prices of food and energy--has remained moderate. However, the price of crude oil has continued its rise over the past month, a rise that will be reflected in gasoline and heating oil prices and, of course, in the overall inflation rate in the near term. Moreover, increases in food prices and in the prices of some imported goods have the potential to put additional pressures on inflation and inflation expectations. The effectiveness of monetary policy depends critically on maintaining the public’s confidence that inflation will be well controlled. We are accordingly monitoring inflation developments closely.

The incoming data on economic activity and prices will help to shape the Committee’s outlook for the economy; however, the outlook has also been importantly affected over the past month by renewed turbulence in financial markets, which has partially reversed the improvement that occurred in September and October. Investors have focused on continued credit losses and write-downs across a number of financial institutions, prompted in many cases by credit-rating agencies’ downgrades of securities backed by residential mortgages. The fresh wave of investor concern has contributed in recent weeks to a decline in equity values, a widening of risk spreads for many credit products (not only those related to housing), and increased short-term funding pressures. These developments have resulted in a further tightening in financial conditions, which has the potential to impose additional restraint on activity in housing markets and in other credit-sensitive sectors. Needless to say, the Federal Reserve is following the evolution of financial conditions carefully, with particular attention to the question of how strains in financial markets might affect the broader economy.

full speech

Why the pressure is all on the FED

The fact is that the evolution of the global markets is mostly relying on the shoulders of the Federal Reserve. This is not really a good thing as any decision to be taken by the Fed will have negative consequences. It does not really have as much wiggle room as other central banks.

Take the ECB (European Central Bank) for example. Its decision is actually helped by the Fed's activity. The ECB has to balance price stability with economic growth. With Europe suffering increasing inflationary pressures at the same time as a slowdown in economic growth, the decision on whether to tighten monetary policy becomes difficult. If it lowers interest rates to boost the economy it could get a real inflation risk. Raise interest rates and the economy could take a further hit.

However, general market forces will help the ECB to make its decision as well. Although the strong euro has been strongly criticized, the fact is that it is not really hurting exports as much as economists feared. With exports sustained, the ECB does not have to greatly worry about it hurting economic growth. Why are exports sustained?, because the Euro mostly revalued against the dollar. Therefore, exports are simply moving away from the U.S. towards China and other emerging countries. On the other hand, Europeans are seeing an increasing buying power. This helps imports increase as foreign products are getting relatively cheaper. Furthermore, cheaper products help control inflation. For example, with oil priced in dollars, the high euro makes up for part of the higher oil prices.

SO, the higher euro is helping Europe fight inflation. However, the latest indicators show that inflation might be starting to increase in Europe. Therefore, increasing interest rates is not out of the question just yet.

Although economic growth is slowing down in Europe and the credit crisis is being felt, boosting the economy is not as urgent for ECB since the FED is already lowering their interest rates. After all, the credit crisis originated in the United States and more dire measures will have to be taken in that country.

In other words, the FED cutting interest rates is helping the ECB with its objectives. Lower interest rates for the dollar is helping to ease the credit crisis and will help mitigate the spill-over effects to other countries. At the same time, it drives a weaker dollar which in turns helps Europe control inflation, especially on dollar-denominated commodity prices.

U.S. inflation could head into real danger. Consumer prices have been remarkably resilient so far as it remains very close to the 2% level. However, with the Fed passing more cuts, it sets up a real inflationary risk with a steeply declining dollar.

US Data..Just Released

US GDP revised to 4.9%... meets estimates.

Weekly Initial Claims = 352K vs expected 330K.... continuous claims highest in 2 years


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