Everyone admits that the US Fed is in a pickle

Foreign Currency Exchange Outlook: The balanced outlook in the most recent Fed policy meeting minutes has been overridden by events since the meeting. While Bernanke’s speech yesterday was largely ignored by all the markets, which were beguiled instead of falling oil and rising stocks, nobody missed the implication of his remarks—-that the Fed is on hold for a very long time. All the major bank economists are busily re-writing their forecasts. Market News picks up one that is chilling—HSBC cut its second-half GDP forecast to under 1% and sees “a 45pc probability of a 50 bp Fed interest rate cut to 1.50%."

Well, 45pc is not over 50pc, but the mere mention of a cut is terrifying. We imagine that scenario is realistic only if we actually do get additional bank failures.

Remember, banks have disclosed about 420 billion US Dollars in housing-related losses, while some experts, including the IMF, put the estimate at 1 trillion US Dollars or more. Several important figures have said the worst is over but that doesn’t mean all the bad news is out. If fresh bad news is over-weighted, the crisis is not over and could take some strange turns.

Everyone admits that the Fed is in a pickle.

We have rising inflation and it’s becoming obvious that higher fuel and food prices are starting to spill over to core inflation. Normally the Fed would be waving its arms and talking about upside risks. While Bernanke did talk about upside risks, he is also talking about downside risks to growth from the contracting housing and banking sectors, and still fighting off whatever potential bank failures might be lurking in the bushes. No central bank wants to be seen hiking interest rates just as some banks are failing—it makes them look stupid and insensitive.

We get stupid and insensitive from elected officials and expect better of the US Fed.

If oil prices continue to correct today, we agree that the US dollar can regain some strength, perhaps to 1.5745 or so, which is the bottom of the channel drawn off the June euro low. But only if the euro falls under the June 7 low of 1.5608 can we start to buy into a real US Dollar rally. In addition to falling oil, that would take good bank earnings this week, a serious exit by shorts when the new rules come in next week, ongoing stock market gains, a rise in US Treasury yields, and calm acceptance of the Freddie/Fannie rescue.

Oh, and data can’t be too bad, either, and talks with Iran need to be promising this weekend.

It’s a lot to hope for.

Bye for Now

Barbara Rockefeller