Is the Fed just jawboning?

I tend to think so. Yesterday, 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.

  1. barryschaeffer says


    A lot of smart people (T2 Associates, Alan Abelson, others) are predicting two more big waves of problems in the home mortgage space in 2010 and 2011, especially Alt-A and Option-ARM resets.

    It seems to my feeble brain that the Political Will to finance more big deficits will materialize when the first of these waves crashes ashore.

    Are my facts or my analysis flawed?


    1. Edward Harrison says

      I think deficit spending is done. The will will not return because we are adding double digit percentage deficits to GDP. I said in january that Obama gets one shot at major stimulus spending and that’s it. If we get a second dip, that’s all she wrote, Barry.

  2. barryschaeffer says


    In your view, how will emerging markets (for both equity and debt) behave in your “Recession is Over;Depression is just beginning” scenario? After all, don’t many emerging markets have much stronger banks and a less indebted home sector?


    1. Edward Harrison says

      Emerging markets have zoomed even further than American markets. I see them as not-yet de-coupled and very high beta. That means they are great during the upswing, but vulnerable to crashes during downswings. Over the longer-term, EM should outperform as many countries in Asia in particular have better growth potential. You also look at a country like Brazil and you don’t see a lot of the demographic problems you get in the likes of Russia and China. The same is true in India.

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