Curiouser and Curiouser

In response to the disappointing preliminary Q2, the market took bond yields lower and the dollar with it. The market downgraded the likelihood of a Fed hike on August 8. Indicative pricing in the Fed funds futures market implies the odds of a hike have fallen to about a 33% chance, the lowest since mid-June and well off the 85% chance seen at the start of the month and even as recently as July 19th. The risk is that the market is exaggerating the significance of Q2 GDP on the formulation of the monetary policy in the middle of Q3. Moreover, the data will not tell Fed policy makers anything it did not already know. Economic growth moderated and price pressures remain elevated and above the Fed’s comfort–zone.

Bernanke Preview

Given the heightened uncertainty about the near-term outlook for US monetary policy, this week’s semi-annual congressional testimony by the Federal Reserve Chairman will be closely scrutinized for clues. Federal Reserve Chairman Ben Bernanke’s semi-annual testimony before Congress this week is looked.

The risk is that the market is disappointed. Fed officials have gone to pains to emphasize that policy is data dependent. There simply has not been much in way of critical economic data since the June 29 FOMC and the accompanying statement. The ISM survey data was consistent with the moderation in activity and stabilization in prices. The June employment data was mixed.

Could Bernanke be Dollar Negative?

The US dollar has recovered nicely from the sell-off that culminated in the immediate aftermath of the disappointing jobs data at the start of the month. These gains were scored despite the movement of interest rate differentials against the US. The fact that the premium the US offers over the euro-zone has narrowed also means that US debt instruments have outperformed Europe’s. There could be a number of possible reasons why US debt instruments are out-performing. However, given that the market continues to lean toward a Fed hike at the August 8 FOMC meeting, it is not because of a dovish outlook for US monetary policy. Rather, given the larger environment, US debt instruments appear to be benefiting from safe haven flows as capital reacts to the geo-political tensions and equity market slides. The emerging market equities looked to have stabilized since the middle of June but have turned down again.