US Fed: Is the FOMC Preparing the Markets for a Pause in June?

For the most part, commentary by Federal Reserve officials has been focused on strong price pressures in the US economy. While FOMC Chairman Bernanke did note that the financial markets have yet to truly normalize, his recent speech on the Fed’s liquidity provisions suggests that this will continue to be the method of dealing with the credit crunch, rather than outright cuts to the target fed funds rate. However, economic conditions in the US remain perilous as the labor markets deteriorate and the housing collapse continues, which has led to speculation that the FOMC will continue cutting rates. Nevertheless, FOMC commentary and futures that are pricing in a 94 percent chance of no change in rates in June completely contradict this theory, and as we’ve found consistently, the markets are almost always right.

Ben Bernanke, Federal Reserve Chairman

“Turmoil in financial markets has eased somewhat, but the situation is still far from normal.” – May 13, 2008

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

“While even the core price measures in the United States are rising somewhat faster than I would prefer, and inflation presents a key risk to my outlook, I believe that the Federal Reserve's policy strategy remains compatible with a low and stable inflation rate.” – May 13, 2008

“Inflation refers to deterioration in the purchasing power of money. It occurs when a central bank creates more money than the public wants to hold...Relative-price changes convey important information about the scarcity of particular goods and services...I have drawn a subtle, but important distinction between relative-price pressures and inflation. Central banks cannot do anything about relative prices. We do not produce oil, wheat, rice, or any other commodities. But through our monetary policy actions, we can create or prevent inflation.” – May 13, 2008

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

"...core inflation remains on the high side of where I would like it to be. At the same time, activity is weak across most sectors of the economy...I consider the current level of monetary accommodation to be appropriate. That, together with the fiscal package, should be sufficient to promote a gradual step up to moderate economic growth later this year. Likewise, I would expect that inflation will moderate in coming quarters, as more slack in labor and product markets emerges and as commodity prices level off." – May 13, 2008

Charles Evans, Federal Reserve Bank of Chicago President (Alternate Voting Member)

“We think conditions will improve in the second half of this year, but not enough to prevent economic activity from still running at a relatively sluggish pace. We expect real GDP growth will return close to potential as we move through 2009.” – May 13, 2008

ECB: Rates on Hold at 4.00%....Until When?

The European Central Bank left rates steady last week at 4.00%, but the big surprise for the markets was just how hawkish ECB President Trichet remained. Indeed, Trichet brushed off the easing in estimates for Euro-zone CPI to 3.3 percent from 3.6 percent, as this is still well above the ECB’s 2 percent target. While Spanish Finance Minister Solbes supported the ECB’s “prudent” actions, he did suggest that the central bank would be more ready to discuss cutting rates toward the end of the year, as long as CPI fell closer to target.

Jean-Claude Trichet, European Central Bank President

“The latest data and survey information on economic activity confirm previous expectations of moderate but ongoing growth in the first half of 2008. In particular, industrial production data for the first months of the year showed resilience, while economic sentiment generally continued to soften.” – May 8, 2008

“The latest information confirms our assessment that upside risks to price stability prevails over the medium term, in a context of continuing very vigorous money and credit growth. At the same time, the economic fundamentals of the euro area are sound, and incoming macroeconomic data continue to point to moderate but ongoing real GDP growth. However, the level of uncertainty resulting from the turmoil in financial markets remains unusually high and tensions still persist. Against this background, we emphasise that maintaining price stability in the medium term is our primary objective in accordance with our mandate. The firm anchoring of medium to longer-term inflation expectations is of the highest priority. The Governing Council remains strongly committed to preventing second-round effects and the materialization of upside risks to price stability over the medium term.” – May 8, 2008

“Domestic price stability is also a precondition for economic stability in the face of external shocks. A strong focus on domestic price stability also facilitates efficient adjustment of the economy to macroeconomic shocks.” – May 12, 2008

Pedro Solbes, Spanish Finance Minister

"In my opinion, as long as prices don't fall, it is logical, comprehensible for the ECB to be prudent." Solbes also said that he expects annual inflation to fall closer to 2 percent later this year, and "then it will be easier to have this sort of debate (cutting interest rates)." -- May 13, 2008

Richard Lee is a Currency Strategist at FXCM.