This Wednesday, Fed Chairman Ben Bernanke will give his semiannual testimony on monetary policy to the House. After the last FOMC statement said that “a sustained moderation in inflation pressures has yet to be convincingly demonstrated,” Bernanke may ignore an expected slowdown in headline CPI – due to be released at 8:30 EST on the same day – and instead focus on a possible acceleration in core CPI.

US Fed – Dollar May Gain On Hawkish Testimony By Bernanke
BOE – 6.00% In The Cards
RBNZ – Can The New Zealand Economy Handle A Hike To 8.25%?

Yield Spread Analysis 07/10 – 07/17

Global government bond price action diverged over the course of the past week as worries regarding the impact of the re-pricing of subprime-mortgage backed bonds dissipated. Instead, economic data proved to be a strong market-mover. For example, New Zealand short term yields saw a whopping 16 basis point boost over the course of the week, outpacing a 10 basis point jump in long term yields, as consumer price growth in the second quarter was released at a stronger-than-expected pace. With the RBNZ scheduled to meet on July 26th, markets are betting that the bank will hike to another record high of 8.25 percent. Meanwhile, the UK yield curve saw very similar rate movements for very similar reasons, as an easing of CPI for the month of June was not as weak as estimated, ramping up speculation of a move up to 6.00 percent in the near-term.

Looking ahead, Fed Chairman Ben Bernanke’s semiannual testimony to the House on monetary policy provides major event risk on Wednesday. Treasury yields have gradually climbed higher as traders are betting on decidedly hawkish commentary by Bernanke with a focus on core inflation.



US Fed – Dollar May Gain On Hawkish Rhetoric By Bernanke This Week

This Wednesday, Fed Chairman Ben Bernanke will give his semiannual testimony on monetary policy to the House. After the last FOMC statement said that “a sustained moderation in inflation pressures has yet to be convincingly demonstrated,” Bernanke may ignore an expected slowdown in headline CPI – due to be released at 8:30 EST on the same day – and instead focus on a possible acceleration in core CPI:

Ben Bernanke, Federal Reserve Chairman

“If inflation expectations are well anchored, changes in energy (and food) prices should have relatively little influence on 'core' inflation, that is, inflation excluding the prices of food and energy.” July 11, 2007

Janet Yellen, Federal Reserve Bank of San Francisco President

“The focus on core is that is seems like it is a better predictor of the underlying trends that will effect total inflation going forward, not because that is the objective of policy. I think markets have a pretty-good understanding of what the Fed is comfortable with in terms of inflation despite lack of a formal target. There is not a great deal of confusion about how we think about price stability in spite of the fact we don't have a specific, agreed-upon numerical objective.” – July 13, 2007

Meanwhile, the Fed still maintains that the problems of the housing sector will not seep into other areas of the economy:

Charles Plosser, Federal Reserve Bank of Philadelphia President

“There are not likely to be significant spillover effects from the housing crunch to the rest of the economy or the financial system.” – July 12, 2007

The ECB, on the other hand, is not entirely convinced:

Nicholas Garganas, European Central Bank Governing Council Member

“There are indications of a qualitative deterioration in the subprime high-yield mortgage loan market in the US. Even though the impact up to now has been limited, the problem may intensify and expand to other markets. Despite the increases by all central banks globally, interest rates remain relatively low.” – July 12, 2007.

BOE – 6.00% In The Cards

After UK CPI for the month of June was released at a hotter-than-expected 2.4 percent, the Bank of England will likely remain concerned that monetary policy is not tight enough to bring inflation down to their 2.0 percent target. However, they will probably need to see another month’s worth of data before enacting another rate hike, creating major risk for a move to 6.00 percent in September:

Andrew Sentence, Bank of England Monetary Policy Committee Member

“My concern over the nine months I have been on the Committee has been to respond to strengthening demand and a rise in inflationary pressures in a timely way. Failure to do that would create the risk that there might be a need to be even higher interest rates and a more pronounced slowdown further down the track…Though we have increased interest rates, there is still quite a lot of momentum in the economy…The Monetary Policy Committee is very keen to ensure that inflation expectations do not begin to creep up in response to a temporary rise in inflation such as we have seen recently, as if could be very costly to bring them down again.” – July 11, 2007

Charles Bean, Bank of England Monetary Policy Committee Member

“The importance of keeping inflation expectations anchored cannot be stressed enough.” – July 13, 2007

John Gieve, Bank of England Monetary Policy Committee Member

“We're continuing to hit growth forecasts despite rising rates and inflation. But we (will) keep our eye on the situation and react accordingly.” – July 11, 2007

RBNZ – Can The New Zealand Economy Handle A Hike To 8.25%?

Continuous rate hikes and resilient consumption growth have pushed the New Zealand dollar to fresh 25 year highs. However, the appreciation of the currency has also made a dent on the export sector, and with price pressures remaining persistent, the policy tightening cycle shows no signs of ending. Can RBNZ Governor Bollard concoct the perfect mix of monetary policy actions and FX intervention measures in order to keep the economy in check?

Michael Cullen, New Zealand Finance Minister

“Growing demand and growing incomes have contributed to persistent inflation, high interest rates and an over-valued exchange rate, all of which put pressure on the productive sector…The economy is continuing to grow unsustainably fast.'' – July 12, 2007

“Those people pushing money into the NZD have to realize the correction will occur at some point and they're exposed to risk around that…This country has got to shift its behavior over time away from consumption-led growth to savings and investment-led growth.” – July 17, 2007

“The government is acutely aware of the pain the high NZ dollar is causing much of the export sector.” – July 16, 2007

Alan Bollard, Reserve Bank of New Zealand Governor

“Overt intervention intended to affect the exchange rate directly may still occur. In addition, the Bank will be able to more gradually accumulate or reduce its foreign exchange position when the exchange rate is at extreme levels and unjustified by medium-term economic fundamentals…However, such transactions will allow the Bank to give concrete signals regarding the extent to which the exchange rate is seen as over- or under-valued. That may indirectly affect the exchange rate by discouraging speculators from pushing the currency to extreme levels.” – July 13, 2007

Terri Belkas is a Currency Strategist at FXCM.