Ben Bernanke: What Kind of Bird Is This?

For weeks now, Fed Chairman Ben Bernanke has begun using “hawkish rhetoric” regarding inflation and the US dollar.

If the phrase “hawkish rhetoric” sounds a bit odd to you, it’s Wall Street speak for kind-of, sort-of, not really, but possibly indicating that the Federal Reserve will raise interest rates to combat inflation and strengthen the dollar.

The opposite of “hawkish rhetoric” is “dovish comments” which indicate the likelihood of interest rate cuts which typically weaken the dollar and strengthen equities, particularly financials.

I have to admit, it is very difficult to make economic forecasts in this environment. The stakes of this particular poker game are tremendously high—trash the dollar, or throw Wall Street to the sharks— and the Fed Chairman’s main options are “worse” or “worser.”

I’ve broken down his choices and the likely results into two arguments: The Hawk and the Dove.

The Hawk: Raise Rates

In this option, Bernanke will back up his hawkish rhetoric by raising interest rates. Many market participants have already bet that this will happen. Futures forecast a 76% chance of a 0.25% rate hike in August and 100% chance of a 0.5% increase in October.

If this were to happen, the dollar would strengthen, commodities would correct, and financial firms would be toast.

This seems to be the most logical choice. But thus far Bernanke has operated in anything but a logical fashion. If he were pro-dollar and anti-Wall Street, he would not have cut the Fed Funds rate from 5.25% to 2% in a matter of nine months.

Similarly, he would not be having lunch with Wall Street firms— as he did a few days before the Bear Stearns (BSC) bailout. And he would not be turning the Fed’s balance sheet into a toxic waste dump by letting Wall Street exchange their mortgage-backed securities for treasuries.

So the market expects Bernanke to raise rates… but it would represent a complete 180 from his actions thus far.

The Dove: Cut Rates or Leave Them Be

In this option, Bernanke will continue to cut rates or leave them be. Next to no one seems to believe he will do this—again the market has forecast a 100% chance of a rate hike by October.

If this were to happen, stocks, led by financials, would rally, though the rally would likely be short-lived. At this point there are fewer and fewer market participants who believe the worst is over for Wall Street firms. This is most evident in the failure of key financials to remain above the prices of their recent offerings— both Lehman Brothers (LEH) and Citigroup (C) have seen shares plunge below offering prices within a week of the offering.

However, a rate cut would certainly help financials tread water. It would also send the dollar to new lows, pushing commodities higher, and fanning the flames of inflation. With 76% of Americans already wanting a stronger dollar, this could also become a raging political issue— especially in an election year— that could put pressure on the Fed Chairman to put out inflation or be removed from office.

Finally, I’d like to introduce a third option: the Dodo.

The Dodo: Dress the Dove Up Like a Hawk

This, to me, seems the most likely option. So far, Bernanke’s hawkish rhetoric has proved to be exactly that: rhetoric. A quick look at the monetary supply shows he’s been pumping his brains out while talking hawk— note the acceleration in May.

Under this option, Bernanke will continue to talk about inflation, but won’t do anything about it. The dollar will rally temporarily based on his talk, commodities— particularly oil— may enter brief corrections, and equities may stage a “dead cat bounce.” But soon the market will figure out that Ben’s no hawk. The dollar will then resume its descent, equities will continue plunging— with brief dramatic rallies— and commodities will hit new highs.

I refer to this option as the “Dodo” for several reasons. We’ve already seen two central banks fail during the history of the US. With this policy in place, the stage is set for the third —our current one— to join the first two. At that point, Bernanke and his board will suffer the same destiny as the bird for which this option is named.

Disclosure: None

Comments

[Walt Thiessen]

Well said. And when the current central bank (The Fed) finally fails, I'll say "Good riddance!"

Of course, who knows what horrible idea (ie new central bank) Congress will come up with to replace it?

America needs to learn what the bankers are up to. This isn't just an investor's need. It's the need of every voting American. Until that happens, we're going to be financially shred by one central bank after another.

[John Pseudonym]

The Fed will do whatever it takes to keep stocks "healthy" through the election; that you can bet on!

Can they fight back the forces that are trying to sink the market?

They will, or they will die trying.

[moonbat1775]

Enough has been written condemning central (fractional reserve) banking to sink the British Isles where it originated with the Bank of England in 1694 to enrich bankers and Charles II.

I will just say this: It's foundations are FRAUD and THEFT via inflation. Is it any wonder that this system periodically leads to disaster?

<i>John Maynard Keynes,
you have your fun.
But we find we're living
in your "long run"<i>

[moonbat1775]

John Maynard Keynes,
you've had your fun.
But we find we're living
in your "long run".

[Hooligan1]

You ask what banking system will arise from the ashes of the Federal Reserve -- Why the World Bank, of course.

[Skjellifetti]

What is the MZW in your graph?

[Jon T.]

Japan's lost decade 2.0, American Style. The fed is stuck in limbo for quite some time to come, until the rotting decay brought about by a total breakdown in lending standards has run its course. That will probably take another five years, minimum. There will be lots of jawboning along the way while all the while the decay will continue to spread. And then one day it will be complete. Let's all hope its by 2015. That would be great! Let's be realistic here folks. Nothing can be done but to allow time to pass, a lot of time to clear a major and historical mishap in structured finance. And maybe we'll learn that a kid making minimum wage at a fast food establishment can not afford a $600,000 home. That is the real and profound lesson to be learned here. You'd think someone would have thought of that at the time. Huh? Strange, isn't it? Aren't these guys supposed to be the smartest ones in the room? Oh yeah, they are. They got away with the loot. :)

[icandoitdon]

i think forecasts of the fed's demise are way off base. it's too good a whipping boy for congress.

what is dispensible is a fed chairman. good riddance. he and greenspan are the "dumb and dumber" of modern economics.

[SEANM]

What kind of bird? A cuckoo bird. It was laid covertly with the fullest intention to deceive and supplant. The productive economy is thrown out of the safety of the nest and the financial cuckoo is devouring everything. The dumbarse government continues to feed it. The end game is us verses them. kill or be killed. bullets for bankers-both investment and commercial.