The Federal Reserve is pulling out all the stops, as the Bank announced on Tuesday morning that they would expand their securities lending program in an attempt to instill stability in the financial markets. Furthermore, the Fed joined forces with the ECB and SNB to triple the size of existing swap lines, which will allow them to borrow dollars from the US central bank and then lend the dollars to their own banks. The moves indicate that the Fed is now in panic mode as they fight to prevent a seizure in the credit markets. How about that pesky inflation issue? Crude oil has gone on to hit yet another record of $110/bbl, but with economic indicators pointing towards recession, the FOMC has brushed off the building price pressures and will continue to slash the fed funds rate aggressively.

Yield Spread Analysis 03/04 – 03/11

After the Federal Reserve announced measures to try to prevent a more severe credit crunch, yield curves flattened globally as short-term yields spiked amidst a major comeback of risk-seeking behavior. Indeed, equity markets in Europe surged on the news while shares in the US opened higher. However, it may only be a matter of time before government bonds resume their ascent, as the Federal Reserve is almost guaranteed to cut rates on March 18, and there is little hope that a global economic slowdown can be fully averted.

Looking ahead to the rest of the week, US economic data on Thursday and Friday provides substantial event risk as retail sales and inflation figures will be released. Consumption is expected to have held up in February, though the gains will likely be the result of price increases. Interestingly enough, CPI growth is forecasted to have cooled slightly, which would only support the case for additional rate cuts by the Federal Reserve and could set Treasury yields and the US dollar up for losses.

US Fed: Is Bernanke More Concerned About a Recession, Inflation, or the Credit Crunch?

The Federal Reserve is pulling out all the stops, as the Bank announced on Tuesday morning that they would expand their securities lending program in an attempt to instill stability in the financial markets. Furthermore, the Fed joined forces with the ECB and SNB to triple the size of existing swap lines, which will allow them to borrow dollars from the US central bank and then lend the dollars to their own banks. The moves indicate that the Fed is now in panic mode as they fight to prevent a seizure in the credit markets. How about that pesky inflation issue? Crude oil has gone on to hit yet another record of $110/bbl, but with economic indicators pointing towards recession, the FOMC has brushed off the building price pressures and will continue to slash the fed funds rate aggressively.

How much do you think the Federal Reserve will cut rates by on March 18? Vote in our poll and discuss the topic in the DailyFX Forum.

Ben Bernanke, Federal Reserve Board Chairman (Voting Member)

“In many cases, when a homeowner has little or no equity left, a stressed borrower has less ability and less financial incentive to try to remain in the home. In this environment, principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure.” – March 4, 2008

Frederic Mishkin, Federal Reserve Board Governor (Voting Member)

“The first of the reasons (why the dollar's inflation threat is limited) is that exporters usually price to market. They aren't able to raise their markups to compensate for the currency decline any more than they think the market will bear without losing sales to competitors. Second, exporters often price their products in the first place in the currency of the country to which they are selling. That's especially true in the United States because of the role the dollar plays in world markets. And third, in-country transportation and distribution costs, unaffected by exchange rates, make up a large portion of the final sales price of many goods.” – March 7, 2008

Richard Fisher, Federal Reserve Bank of Dallas President (Voting Member)

“We are supposedly and are, in practice, a contemplative group. Reacting to pressures in the short term is a mistake. We should not be reactive but contemplative.” – March 7, 2008

Sandra Pianalto, Federal Reserve Bank of Cleveland President (Voting Member)

“Economic activity is, in fact, highly vulnerable to a credit crunch and our policy actions have been aggressive.” – March 6, 2008

Janet Yellen, Federal Reserve Bank of San Francisco President (Alternate Voting Member)

“Even so, I expect both total and core inflation to moderate over the next few years, to under 2 percent, an outcome that is broadly consistent with my interpretation of the Fed's price stability mandate. And I see the risks to this outcome as roughly balanced.” – March 7, 2008

ECB: Rate Cuts, Intervention Unlikely as the Strong Euro is Helping to Cool Inflation

The fact that the ECB remains staunchly hawkish has done little to cap the euro’s surge to record highs. However, some jaw-boning by ECB President Trichet did the trick for a short time on Monday as he said he was “concerned about excessive exchange-rate moves.” Verbal intervention by European officials is fairly common, but the extent of the currency’s gains have left many wondering if they will physically intervene in the markets. As we mentioned in our special report on FX intervention, the ECB is unlikely to take such drastic action, as the high value of the euro has helped prevent import price inflation from accelerating.

Jean-Claude Trichet, European Central Bank President

“We, in the Eurosystem, are very closely monitoring the ongoing significant market correction we have experienced since the middle of last year, taking into account all their possible consequences, including on inflation. Global events could become so important in driving inflation that they affect the conduct of monetary policy. It could be that the traditional links between inflation and "domestic" variables - particularly the level of unemployment - have became obsolete in a world where emerging Asia as well as previous communist countries provide such a large amount of labor at low cost.” – March 7, 2008

“We believe the current monetary policy stance will contribute to reining in price pressures.” – March 6, 2008

Axel Weber, European Central Bank Governing Council Member

“Demand is broadly based and supported by increasing employment. Therefore we are sticking to our forecast that GDP growth should be around potential. It is not at all sure that the average inflation rate will subside significantly.” – March 11, 2008

“Taken all together, the current policy stance in the euro area has to be judged as contributing to achieving our medium-term objective of price stability. Weaker growth prospects do not pose sufficient reason to expect a dampening of inflationary pressures in the foreseeable future.” – March 7, 2008

Michael Glos, German Economy Minister

“We are concerned about domestic demand. There are a various signs that Germans' willingness to consume and spend isn't as we wished for.” – March 11, 2008

Richard Lee is a Currency Strategist at FXCM.