The US housing sector – the Achilles’ heel of the economy - continues to be a much-discussed issue by Fed members as it has the potential to prolong the recent slowdown in expansion. However, with monetary policy makers remaining hawkish on inflation, the US dollar may benefit as it appears that rates have almost no chance of being cut.

Yield Spread Analysis 06/12 – 06/19

Yields around the globe have fallen back after surging to multi-year highs as the steep plunge in government bond prices have finally shown a recovery. Long-term yields in the US and Canada have taken the biggest hit, especially after softer US economic data has hurt prospects for rate hikes by the Fed while weaker Canadian CPI has quelled fears of aggressive policy action by the BOC. Meanwhile, Swiss long term rates have also fallen even after the SNB’s rate hike to 2.50 percent as markets are not expecting much in the way of rate normalization this year.

Looking ahead, the release of the minutes from the BOE’s meeting earlier in the month could have major impact on Gilts. The risk lies in how the policy makers voted, as just a few members in favor of a hike would ramp up expectations for action in July. On the other hand, a unanimous vote for steady rates could signal a repeat next month.



US Fed – Homegrown Slowdown?

The US housing sector – the Achilles’ heel of the economy - continues to be a much-discussed issue by Fed members as it has the potential to prolong the recent slowdown in expansion:

Ben Bernanke, Federal Reserve Chairman (Voting Member)

“Changes in home values may affect household borrowing and spending somewhat more than economists have traditionally assumed.” – June 15, 2007

Randall Kroszner, Federal Reserve Governor (Voting Member)

“The Federal Reserve needs to walk a fine line fighting abuses in subprime mortgage lending.” – June 14, 2007

However, with monetary policy makers remaining hawkish on inflation, it appears that rates have no chance of being cut:

Michael Moskow, Federal Reserve Bank of Chicago President (Voting Member)

“US inflation is coming down more rapidly than anticipated but still warrants close monitoring.” – June 14, 2007

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

“Our job in terms of dealing with expectations or underlying forces that give rise to inflation impulses will continue regardless of what happens in the marketplace…If the Fed does its job, then we can accommodate economic growth and keep inflation down.” – June 14, 2007

RBA – Slow And Steady Wins The (Inflation Fighting) Race

The Reserve Bank of Australia has taken a much slower approach to policy tightening compared to central banks like the Reserve Bank of New Zealand. As a result, inflation and expansion are gradually brewing, and their hawkish bias should keep the Australian dollar rally in tact:

Glenn Stevens, Reserve Bank of Australia Governor

“The country's inflation rate is likely to pick up pace next year, rather than receding.” – June 14, 2007

“Whether or not further installments in that sequence will be needed is a question the board will continue to address over the months ahead…On the one hand, the medium-term concerns about inflation remain. That is cause enough to err on the cautious side in setting policy, and to ask whether current settings are restrictive enough. On the other hand, the somewhat lower short-term inflation outlook means that the starting point for a future pick-up in inflation is likely to be a bit lower than earlier thought. This has afforded some additional time in which to assess trends in demand and the economy's capacity to meet them.” – June 14, 2007

Peter Costello, Australian Treasurer

“If you look at the last two quarters of productivity, there's been a huge surge…We will have another strong productivity cycle. You will see once all the increased investment starts working out in production, if it rains and the drought turns.” – June 19, 2007

ECB – On Hold Until Year End

While the European Central Bank maintains that rates remain accommodative, they appear anxious to stress that any additional hikes may not occur in the short-term:

Jean-Claude Trichet, European Central Bank President

“It would be naïve to think that the effects of globalization on inflation go in one direction only,” referring to the “upward pressure on prices for mining products and fossil fuels as well as in some areas of agriculture.” – June 18, 2007

Jose Manuel Gonzalez-Paramo, European Central Bank Executive Board Member

“Central bankers should stress the 'conditional' nature of the guidance provided to the markets and should also limit the horizon of reference to the very short term, without pre-committing to a specific path of policy rates that they may be obliged to renege on in the future.” – June 15, 2007

Axel Weber, European Central Bank Governing Council Member

“We see risks for price stability. On average, the inflation rate should lie above our upper limit for price stability this year and next, according to our estimates. I don’t see any danger for economic performance.” – June 18, 2007

Nicholas Garganas, European Central Bank Governing Council Member

“You must always bear in mind that when necessary we are prepared to act in a firm manner to ensure that we achieve our objective, to make sure that risks to price stability do not materialize…we don't predetermine our actions. We will make our decisions on the basis of incoming data.” – June 13, 2007

BOJ – No Hope For Hikes Keeps Carry Trades In Play

Bank of Japan Governor Fukui seems to be turning a more dovish tone – though he denies holding any bias – while simultaneously quashing speculation of rate normalization in July. Unsurprisingly, the central bank is not likely to even consider policy action until August, after the LDP elections:

Toshihiko Fukui, Bank of Japan Governor

“I'm not being either hawkish or dovish when making interest rate decisions with my fellow BOJ policy board members. The Japanese economy has been moving along the projections the BOJ made in its last outlook report issued in April. The bank will gradually adjust interest rates in step with improvements in the economy and prices.” – June 19, 2007

“As for the future rate hikes, we must watch more economic data to check whether the economy and prices move as we've expected…Any rate adjustment isn't directly linked to the BOJ's interim assessment of the economy and prices scheduled in July.” – June 15, 2007

Koji Omi, Japanese Finance Minister

“While I won't comment on daily currency moves, I will closely monitor them…foreign exchange levels should reflect economic fundamentals…Japan’s economic fundamentals are solid.” – June 19, 2007

Hiroko Ota, Japanese Economic and Fiscal Policy Minister

“Exports from Japan to the US have been declining recently. Though I think that some good economic indicators (released recently) mean the chance of a US soft-landing is increasing, I still want to monitor (the economy there) carefully.” – June 15, 2007

Yasuhisa Shiozaki, Japanese Chief Cabinet Secretary

“Monetary policy is exclusively the matter of the Bank of Japan. I'd like them to make their own decisions consistent with Abe administration policies.” – June 13, 2007

Terri Belkas is a Currency Analyst for FXCM.