The Federal Reserve has shown almost no change in bias regarding monetary policy, leading the US dollar and Treasury yields to dwindle. Nevertheless, with crude oil still well above $70/bbl, economic growth faces additional hurdles, especially if energy prices feed into broader inflation pressures.

US Fed – Lackluster Rhetoric Leaves Hike Expectations Lagging
BOE – Will They Wait And See Or Take Preemptive Action?
ECB – Taking It Down A Notch

Yield Spread Analysis 07/17 – 07/24

Global government bond yields have plummeted over the past week, especially on the long-term end, as risk aversion permeated through the markets and sent prices soaring higher. Last Thursday, the S&P reduced ratings on 75 US CDOs made up of subprime mortgage derivatives. Then, the following day, the agency lowered 14 ratings on European CDOs, signaling that issues surrounding risky derivatives are not contained just to the US. Meanwhile, US bond yields were especially hurt by the lack of an overtly hawkish stance by Fed Chairman Ben Bernanke during his testimony to the House and Senate led rate hike expectations to diminish.

Looking ahead, New Zealand bonds may see substantial volatility on Wednesday as the Reserve Bank of New Zealand is anticipated to raise rates to yet another record of 8.25 percent. On Friday, US Q2 GDP could shake things up as a strong rebound has the potential to send Treasury yields rocketing higher.



US Fed – Lackluster Rhetoric Leaves Hike Expectations Lagging

The Federal Reserve has shown almost no change in bias regarding monetary policy, leading the US dollar and Treasury yields to dwindle. Nevertheless, with crude oil still well above $70/bbl, economic growth faces additional hurdles, especially if energy prices feed into broader inflation pressures:

Ben Bernanke, Federal Reserve Chairman 

“The credit losses associated with subprime have come to light and they are fairly significant…some estimates are in the order of between $50 billion and $100 billion of losses associated with subprime credit problems.” – July 20, 2007

“Overall, the US economy appears likely to expand at a moderate pace over the second half of 2007, with growth then strengthening a bit in 2008 to a rate close to the economy's underlying trend…The FOMC has consistently stated that upside risks to inflation are its predominant policy concern.” – July 19, 2007

Thomas Hoenig, Federal Reserve Bank of Kansas City President

“As you look at the economy and you weigh these risks right now, I can make a case for…both an easing or tightening as you move forward…we've seen some favorable numbers on core CPI back towards 2 percent. It's not there yet but it's getting very close…If the downside risks [relating to largely to housing] were to materialize, there would be pressure to ease. On the other hand, if…we saw inflationary pressure, then you (would) see greater pressure to move policy up.” – July 18, 2007

“It's hard to know exactly what number (in terms of energy price) would cause a pullback in the US economy's strength…we will be paying a lot of attention to energy going forward.” – July 18, 2007

Michael Moskow, Federal Reserve Bank of Chicago President 

“Putting together our best estimates of the trends of labor force growth and productivity growth we at the Chicago Fed think potential GDP growth is lower than it was five years ago, and currently is somewhat below 3 percent.” – July 20, 2007

BOE – Will They Wait And See Or Take Preemptive Action?

After UK CPI for the month of June was released at a hotter-than-expected 2.4 percent, the Bank of England remains concerned that monetary policy is not tight enough to bring inflation down to their 2.0 percent target. However, BOE Governor King has recently signaled a more neutral tone, while other central bankers have shown a decidedly more hawkish stance:

Mervyn King, Bank of England Governor

“We have to look through the short-term volatility caused by gas and electricity prices. In our view, inflation will come down during the rest of the year. It is likely to drop further but we will have to wait and see.” – July 19, 2007

John Gieve, Bank of England Deputy Governor

“When we are feeling our way in trying to assess the pressure of demand in the economy, it can often be sensible to move rates gradually so that we can gather more information as we go on the effect of past rises. But, of course, we all know that if we get behind the curve, gradualism could compound the problems.” – July 24, 2007

Tim Besley, Bank of England Monetary Policy Committee Member

“My apparent desire to raise rates, perhaps more quickly than some of my colleagues on the MPC, has been fuelled by a belief that we would be better placed to bring inflation to target in the medium term by doing more sooner. Moreover, the peak of rates may eventually be lower by moving earlier.” – July 20, 2007

ECB – Taking It Down A Notch

Board members of the European Central Bank have been far less hawkish lately, as they have cited inflation pressures infrequently. Nevertheless, expansion throughout the Euro-zone remains a touchstone of ECB commentary, especially as the central bank defends its independence in the face of a rapidly appreciating euro:

Jean-Claude Trichet, European Central Bank President

“This positive development is very encouraging, but this is no time for complacency. Europe still has some way to go to fully benefit from globalization and meet the challenges of rapid technological changes and ageing population. We should also keep in mind that in a context of monetary union, not only fiscal policies, but also price competitiveness and unit labor cost developments across countries should be continuously and closely monitored.” – July 20, 2007

Lucas Papademos, European Central Bank Vice-President

“Currently, the euro-area economy enjoys a solid and broad-based recovery and growth is expected to remain robust in the coming quarters.” – July 23, 2007

Juergen Stark, European Central Bank Board Member

“Euro-zone exporters have not suffered from a strong euro to this point. So far, we have seen a rather gradual appreciation of the euro. We would have a problematic situation should we see abrupt movements.” – July 24, 2007

Terri Belkas is a Currency Strategist at FXCM.