Bernanke Calms the Markets

Good day… And welcome to March. Fed Chairman Bernanke did his best to calm the markets yesterday following Tuesday’s blood bath. “Taking all the new data into account, there is no material change in our expectations for the U.S. economy since I reported to Congress a couple of weeks ago,” Bernanke said. “We are looking for moderate growth in the U.S. economy going forward.” The markets applauded Bernanke’s calm demeanor and lack of ‘Greenspeak’ for which his predecessor was famous. His words were direct and could not be misinterpreted.

Bernanke’s performance came almost a year after communications stumbles led many to question the Fed chief’s commitment to keeping inflation low. His response may elevate his economic credibility and enable him to fight off those who are calling for interest rate cuts later this year.

Not one to be upstaged by his replacement, Former Federal Reserve Chairman Alan Greenspan continued to talk about the possibility of a U.S. recession. Greenspan continues to warn the markets of a pending downturn, but he softened his tone saying that a recession is possible, though not probable this year. “By the end of the year, there is the possibility, but not the probability of the U.S. moving into recession,” Greenspan said. There are specific housing and general inventory excesses that are being addressed quickly, but need to be carefully monitored, he said.

Bernanke, on the other hand, told Congress yesterday that the Fed still expects the economy to pick up by year-end. It will be interesting to see which chairman is correct, the one trying to steer the economy or the one simply speaking his mind.

Largely overlooked was the main reason for Bernanke’s trip to Congress, which was to discuss the federal budget deficit. He used the occasion to repeat his warning of serious consequences to the U.S. economy if plans are not put in place to pay for the government’s future spending obligations. Bernanke said the recent good news on the federal budget deficit was simply “the calm before the storm” for the deficit. Unfortunately the media hardly reported these alarming words as they focused on how he would handle the huge dip in the Dow.

These deficits are going to jump up and bite us, and soon! When they do, we won’t be able to say we weren’t warned. But without pressure from we the people, do you think Congress is actually going to do anything about them? What is wrong with us? We seem to want to follow every twist and turn in the Anna Nicole Smith paternity suit, but no one seems to care about the lack of fiscal responsibility that is leading us down a very scary path! If, or should I say, when these global imbalances start to correct, I have got to believe they will make this 400 point drop in the Dow seem like a little bump in the road. But enough preaching… On to the currency markets!

As everyone expected, fourth quarter GDP was revised down to 2.2% from 3.5% yesterday. Personal consumption was slightly lower, and the Chicago purchasing manager’s index came in below 50 for the second month in a row. None of this data was positive for the economy, but the markets were so happy to see the stocks hanging tough that these numbers were largely ignored. Today we get a plethora of data with personal income and spending, the PCE deflator, weekly jobs data, ISM numbers, construction spending, and vehicle sales. This data will likely confirm a slowing U.S. economy and should be slightly dollar negative.

The Japanese yen rose again dropping below the 118 handle for the first time this year. The yen rose, as a government report showed overseas funds are increasing Japanese bond holdings and less money is leaving the country seeking higher yields. In typical fashion, Japan’s top currency official tried to keep the yen from appreciating too quickly by saying he sees only limited effects from unwinding of so-called carry trades. “There could be some impact of the unwinding, but I believe it is somewhat limited,” said Hiroshi Watanabe, Japan’s top currency official. He said the size of more “speculative” carry-trade investments has been exaggerated. “Some people say the amount of the total carry trade is $1 trillion, but I don’t think so, maybe it’s only tens of trillions of yen,” he said of the “speculative” transactions.

A trillion dollars or a few trillion yen, either way the unwinding of this trade is going to have a positive impact on the Japanese yen and Swiss franc, no matter what the Japanese officials say. We continue to look for that 110 yen/U.S. dollar level sometime this summer.

The euro gained versus the U.S. dollar overnight after a report showed that Europe’s manufacturing growth accelerated in February, adding to expectations the ECB will continue raising interest rates this year. This was terrific news for the euro, as new tax increases, higher borrowing costs, and a slowdown in the pace of U.S. expansion have not been a drag on the European economy. Record low unemployment in bolstering domestic demand after booming exports helped the euro-region economy record the fastest growth in six years in 2006 (seems like I wrote about that yesterday also!). This gain in manufacturing growth all but assures further rate increases in the next few months.

Currencies today: A$.7867, kiwi .6970, C$ .8550, euro 1.3223, sterling 1.9634, Swiss .8202, ISK 66.40, rand 7.2643, krone 6.1239, SEK 7.0101, forint 192.73, zloty 2.9573, koruna 21.38, yen 117.90, baht 33.78, sing 1.5261, HKD 7.8118, INR 44.2625, China 7.7480, pesos 11.1747, dollar index 83.58, Silver $14.25, and Gold$672.95

That’s it for today… They say March rolls in like a lion, and we are supposed to get some nasty weather today (thunder storms, tornados, and hail!). I guess I will have to go down and move my car into the parking garage across the street! Hope everyone has a great Thursday!!

Chuck Bulter — March 03, 2007

The Daily Reckoning