Fed: Jawboning the Market?

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Includes: UDN, UUP
by: Edward Harrison

I tend to think so. Thursday, Ben Bernanke made what some media outlets are calling hawkish statements. This, combined with heavy currency intervention by Asian central banks, helped to strengthen the U.S. dollar. However one must ask if there is anything fundamental about these moves.

Just a few days ago, we got a sensational article via the British Daily the Independent in which a well-respected journalist suggested that a move was afoot to move away from the greenback as the globe’s main reserve currency. This sent the dollar into freefall against a host of major free-floating currencies and gold to an all-time high. I wrote a skeptical post about the report at the time (see my post here). And I think the currency intervention demonstrates why.

Many of the Asian currencies are pegged to the U.S. dollar. So when the greenback declines in value, they are forced to intervene in currency markets to maintain their pegs. If they do not and allow their currencies to appreciate, this hurts export growth in Asia. So clearly, the central banks in Asia do want to upset the apple cart by permitting a freefall in the value of the dollar. Asia is too dependent on export to the U.S. for this to be a preferred policy at this juncture.

Meanwhile, the U.S. does not want a freefall either. Certainly, they want inflation (via a currency depreciation if necessary) but they do not want higher interest rates which is what a freefall would mean. So the Fed is jawboning the market. First, we saw Kohn and Fisher out making hawkish statements. Now it’s Bernanke’s turn.

What Bernanke actually said is that the federal reserve was prepared to withdraw liquidity in a number of ways, the most interesting of which was the so-called reverse repo by which the Fed finances its own portfolio via the banks instead of the of the way around (see story here). Bernanke also mentioned paying interest on reserve deposits, a topic he has broached before. But, the bottom line is this:

My colleagues at the Federal Reserve and I believe that accommodative policies will likely be warranted for an extended period.

This is what Bernanke said in his presentation.

Translation: We are keeping rates at zero percent for the indefinite future, something Bill Dudley at the New York Fed has said as well. The bottom line is that despite what hawks like Hoenig or Fisher might say, we are going to be on easy street for some time to come.