The views expressed in this column are solely those of
the author and do not reflect the views of SVB Financial Group, or Silicon
Valley Bank, or any of its affiliates.
The outcome of last week's long-awaited FOMC event confirmed
the Fed's continued bias toward an accommodative policy. The verbiage of the Fed
statement was little changed and quite close to the market expectations that had
developed in the weeks leading to the meeting. But Chairman Bernanke's inaugural
press briefing hinted that the view of the strong dovish majority, led by
Chairman Bernanke, prevailed. The statement continued to downplay upside risks
to inflation and downside risks to growth.
In reaction, the USD declined dramatically, providing evidence
that extended easy Fed policy will continue to put material pressure on the USD.
The USD suffered its worst monthly performance since October 2010 sinking to
multi-year lows against most currencies. The dollar index rolled to three-year
lows near 73.0. In contrast, stock markets soared on the prospect of a Fed on
hold for the rest of this year while Treasury yields dropped to their lows over
Despite rhetoric from the hawks in the inter-meeting period,
the statement confirmed that there was no formal dissent to unchanged easy
policy. The Fed seems to be content with its wait-and-see attitude towards
inflation and holds the view that the economy is not overheating, thus there is
no rush to tightening. Against that backdrop, a few elements of the FOMC
statement and Bernanke's press conference had surprised the market to such
extent that the USD was driven down to cyclical lows. These elements are:
Economy - The economic recovery was
downgraded, as market expected, from "firmer footing" back to "moderate pace"
according to the statement, while "inflation has picked up in recent months"
was added to preface that underlying inflation trends remaining "subdued."
Inflation - An upgrade of the degree of
inflation concern that investors have been looking for did not emerge in either
the statement or Bernanke's press conference. Only very subtle changes were made
to this section of the statement, as commodity-driven inflation is seen pushing
up inflation "in recent months" vs. "currently," and importantly this is still
seen as "transitory." Rising commodity prices driving inflation higher were
still characterized as "transitory." The Fed seems to have expanded its comfort
zone regarding how core inflation is evolving. Bernanke also dismissed USD
weakness as a factor driving up commodity prices.
QE2 - Though QE2 was forecast to be wrapped up
as scheduled "by the end of the current quarter," Bernanke also indicated that
the Fed would probably maintain the size of its balance sheet in the months to
come, rather than allow some natural shrinkage by not investing in maturing
debt. The Fed is "prepared" to adjust those holdings now, whereas it previously
said it "will adjust the program as needed." Thus, the end of QE2 would be the
end of additional easing, but not the beginning of tightening. Bernanke also
concluded the QE2 was a success, using gains in stock and credit prices as the
measure of success.
Strong USD Policy - The
Chairman's comments on the USD were unconvincing. He said repeatedly that Fed
policy aims to facilitate the conditions for a strong and stable USD in the
medium term. Yet the Chairman and other key Fed speakers have continuously
pushed the emerging markets to allow flexibility in their exchange rates, or a
weaker USD, to correct trade imbalance. An article in last week's Wall
Street Journal also reported that U.S. officials are unfazed by the USD's
decline. It cited that it appears no policy is in the work to the USD's
advantage while some current U.S. policies are some of the factors that drive
the USD lower.
The above revelations in the wake of the latest FOMC meeting
reinforced the view that any shift in the Fed policy will happen slowly and is
contingent on upcoming events. The Fed chief is willing to let the dice roll on
QE2 in the face of both increasing inflation risk and a sub-par recovery. On the
contrary, other central banks are expected to tighten sooner. The European
Central Bank is expected to hike in June/July, given the probability of
substantial upward revisions to the next batch of euro zone inflation data. From
the market perspective, with the prolonged easy Fed policy, there is little to
discourage flows into emerging markets and the ongoing reserve diversification
that have steadily weakened USD versus G10 as well as EM currencies. Current
U.S. easy monetary policies coupled with recent weak U.S. data will work against
the USD in the coming months.
The views expressed in this column are solely those of the author and do not reflect the views of SVB Financial Group, or Silicon Valley Bank, or any of its affiliates. This material, including without limitation the statistical information herein, is provided for informational purposes only. The material is based in part upon information from third-party sources that we believe to be reliable, but which has not been independently verified by us and, as such, we do not represent that the information is accurate or complete. The information should not be viewed as tax, investment, legal or other advice nor is it to be relied on in making an investment or other decisions. You should obtain relevant and specific professional advice before making any investment decision. Nothing relating to the material should be construed as a solicitation or offer, or recommendation, to acquire or dispose of any investment or to engage in any other transaction.
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