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Bernanke Comments Did Not Kill the Dollar, but Can we Trust the Fed?

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The U.S. dollar responded well to all aspects of the Federal Reserve's monetary policy announcement including the release of the FOMC statement, the changes to economic forecasts and Federal Reserve Chairman Ben Bernanke's press conference. Talk of an inflation target stirred some excitement in dollar bulls because even though the central bank is worried about growth, they upgraded their inflation forecast which indicates that price pressures are stronger than they had anticipated. Inflation is expected to subside in the coming quarters but having an inflation target could push the Fed to raise rates earlier than they would otherwise be comfortable with. Although Bernanke said there is nothing imminent on an inflation target, he believes that setting a target will anchor inflation expectations and the prospect of an inflation target has rallied the dollar. The rest of Bernanke's comments were focused on the challenges that lie ahead including the frustratingly slow improvement in the unemployment rate and growth. Like many other central bankers around the world, Bernanke is worried about how the Greek crisis could impact the U.S. economy. Direct exposures in the U.S. are very small, but a Greek default would have a significant impact on global financial markets and in turn the U.S. economy. Yet the dollar still managed to rally because Bernanke could have been much more pessimistic, but he wasn't and instead he went to great lengths to emphasize that the factors hampering growth at this moment should be temporary.

The Fed Chairman began his press conference this afternoon by saying the central bank's estimates were "inherently uncertain." During the Q&A session, he admitted that they don't have a precise read on why the slower pace of growth persists which is a brutally honest admission for a central bank governor but a complete disappointment for investors because what Bernanke is basically telling us that they have no idea how the economy will progress going forward. Considering the high level of unemployment, the thriftiness of consumers and the potential impact of a Greek default on the markets, we can't blame the Fed for not knowing how strongly the economy will perform going forward even if critics will argue that it is their job to know. Nonetheless if the Fed is not confident about their own economic projections, how can they expect investors to believe that the pace of recovery will pick up in the coming quarters? The only certainty is that the Federal Reserve won't be raising interest rates anytime soon and will be keeping their reinvestment program in place until we see a few months of solid non-farm payrolls and retail sales numbers. Although Bernanke admitted that extended period means at least 2 or 3 meetings, in reality he probably means at least 6 to 7 meetings because given the current trend of growth in the U.S. economy, interest rates won't be increased before the end of the year. The central bank now expects the economy to grow by less than 3 percent and for the unemployment rate to remain above 8.5 percent in 2011.

For the time being, the game plan outlined in April remains the same. The Federal Reserve's asset purchase program will be completed at the end of the month and payments from maturing securities will be reinvested for as long as they deem fit. The main takeaway from today's meeting is that there is a lot for the Fed to be worried about and because of that, there is no reason to rush towards the exit. It will take years to reach full employment which means the Fed can keep monetary policy easy for as long as necessary. In fact, Bernanke is keeping the door wide open by saying that more stimulus could be taken if conditions warranted. If a Greek default does roil the markets, causing asset prices to plunge around the world, Bernanke could seriously consider more stimulus but for the time being QE3 is a serious risk for the dollar.

The following table shows the changes made to the Fed's forecasts:

Here is a comparison of the two most recent FOMC statements:

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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