Central Banks Speak: Fed, ECB

Yield Spread Analysis 02/26 - 03/04

Risk aversion is back in a big way as equity markets tumble and investors flee to the safety of government bonds. As a result, yields have slipped quite a bit, particularly in Canada following the Bank of Canada's 50bp rate cut on Tuesday. However, since short-term yields were hit the hardest, the Canadian yield curve reflects a steepening. Similar to the US, this doesn't necessarily reflect an optimistic outlook for the future but rather expectations for continued rate cuts by each country's respective central banks. Meanwhile, Treasury yields have fallen sharply as dovish rhetoric from multiple FOMC members makes it clear that the fed funds rate will be cut by at least another 25bps, if not 50bps, on March 18.

Upcoming rate decisions by the Bank of England and the European Central Bank on Thursday could prove to be market-moving for the fixed income markets. However, with both central banks anticipated to leave rates unchanged, the status of risk aversion and conditions in the global equity markets will likely remain the primary driver.

US Fed: Bernanke & Co. Likely to Keep the Rate Cuts Coming

You know conditions are bad in the US when Federal Open Market Committee members sound remarkably bearish. Indeed, many of these same members were the perpetual cheerleaders for the US economy less than a year ago, but with the housing sector still in a free fall, consumers tightening their purse strings, and the financial markets struggling to stabilize, additional cuts to the federal funds rate are essentially guaranteed.

Ben Bernanke, Federal Reserve Board Chairman (Voting Member)

"If oil prices and food prices do stabilize to some extent, even if they don't fall, that will be sufficient to bring inflation down." - February 28, 2008

"The Fed will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks." - February 27, 2008

Charles Plosser, Federal Reserve Bank of Philadelphia President (Voting Member)

"The current economic environment does have some extraordinary features, namely the tremendous difficulties that are affecting the smooth functioning of capital markets." - March 3, 2008

Frederic Mishkin, Federal Reserve Board Governor (Voting Member)

"While the current troubles in the housing industry stem from a number of causes, a better-informed citizenry would likely have resulted in more-prudent decision making and consequently, less harm to the economy." - February 27, 2008

Donald Kohn, Federal Reserve Board Vice Chairman (Voting Member)

"What policy can do is attempt to limit the fallout on the economy. But easier monetary policy will not forestall a period of economic weakness in the near term." - February 27, 2008

Eric Rosengren, Federal Reserve Bank of Boston President (Non-Voting Member)

"The housing malaise could be more protracted and the recovery more anemic than we have experienced in previous housing downturns." - February 29, 2008

ECB: At 1.50+, Is the Euro Too High?

While it is not uncommon for European officials to try to talk down strength in their national currency, policy makers in the Euro-zone have started to show more significant discomfort with the Euro's rapid appreciation above the 1.50 level, especially as the ECB's hawkish rhetoric has only aided the currency's rise:

Jean-Claude Juncker, Euro Group Chairman

"Today, for the first time in our agreed terms of reference we (Euro-zone finance ministers and ECB President Trichet) say that in the present circumstances we are concerned about excessive exchange rate moves. We have never previously said that we were concerned on the basis of current circumstances. We don't think the recent moves are reflecting economic fundamentals." - March 4, 2008

Dominique Strauss-Kahn, IMF Managing Director

"The euro's problem is that the European Central Bank, which does its job of containing inflation well, is over powerful. It does not have a political counterweight in the form of a real European finance minister in charge of economic growth. The yuan and the yen are undervalued, the euro is overvalued and the dollar is between the two." - March 3, 2008

Nevertheless, with the Governing Council members of the ECB still focused on price stability, they are highly unlikely to back down from their battle against inflation. Furthermore, European officials have been some of the toughest critics when it comes to the lack of currency flexibility in emerging markets like China, which nearly eliminates the chance of official FX intervention.

Axel Weber, European Central Bank Governing Council Member

"Given the background of identified risks for the future of price development and at the same time the markedly weak perspectives for the real economy, the market's present prevailing consensus of interest rate expectations, from my point of view, clearly underestimates the inflation risks. The interest rate expectations for the euro zone also do not represent the monetary policy assessment of a central bank, which is responsible for price stability." - February 27, 2008

Klaus Liebscher, European Central Bank Governing Council Member

"For me, as a policy maker, the price of commodities are crucial, the oil price is crucial, to monetary policy." - March 3, 2008

Lorenzo Bini Smaghi, European Central Bank Governing Council Member

"Downside risks to growth and upside risks to the inflation rate prevail in the euro area." - February 27, 2008

DailyFX

Posted in: Economy,Finance and Investment,Forex