Now that U.S. Federal Reserve Chairman Bernanke has declared the global economy is beginning to emerge from its worst crisis in generations, the emphasis will be on whether central banks continue to work together to prevent a crisis like this from happening again or if each will take its own path to assure the path to recovery is smooth.
One day after Bernanke said “prospects for a return to growth in the near term appear good”, European Central Bank President Trichet said according to Reuters “now that we see some signs confirming that the real economy is starting to get out of the period of ‘free fall’ — which does not mean at all that we do not have a very bumpy road ahead of us — the largest mistake we could make would be to forget the importance and the urgency of this task.”
At first glance it’s hard to say whether Trichet was agreeing with Bernanke or mildly pointing out that there still are major issues facing the U.S. and the Euro Zone. Both of these comments seem to point out the importance of central banks working in a cooperative manner to see that the recovery in the global economy continues to move forward.
It is very clear that over the past year the commitment of the central banks to work in unison helped prevent a complete financial system meltdown and speed up the recovery. The real challenge will be down the road when each central bank begins to receive different readings on their respective economies. It is at this point that the central banks will break from their cooperative efforts and begin to go about business as usual. In this case this will mean raising interest rates. Foreign currency investors will soon be taking positions based on who they feel will emerge from the recession first and who gains the interest rate advantage.
There are already signs that the pace of the recoveries will cause each central bank to react differently. The Fed for instance has already announced the end of its quantitative easing program although it did extend it to October, one month beyond its original ending date. The Bank of England, on the other hand, voted to expand its asset-buyback program at its last meeting on August 6th. Looking at the chart, you can see that the U.S. Dollar gained an advantage on that date that triggered a sell-off in the British Pound market.
The initial reaction by traders to Bernanke’s comments on Friday was to sell the Dollar because of increased demand for higher yielding assets. After giving it a little thought over the weekend, it appears that investors may be interpreting what Bernanke said a little differently and are buying the Dollar in the hope that the U.S. leads the world out of the recession.
Equity markets are up overnight. The strength in Europe and Asia is helping to boost U.S. prices. Bernanke’s positive comments were the driving force behind last Friday’s gains. Traders seem to be focusing on the positive at this time and ignoring the negative. Bank failures are an issue that should begin to make the news. Some analysts are predicting more failures and avoidance of regional bank stocks. Unless there is a dramatic technical reversal on the charts, traders should continue to buy the dips.
Treasury futures are trading higher this morning. Traders have been bucking the norm and supporting the September Bonds and September Notes. Higher equity markets usually mean lower prices for Treasuries because of competition for yields. This is not the case overnight. Furthermore, the increase in supply this week because of the $109 billion auction should also be exerting some kind of downside pressure.
Crude oil is still trading strong but traders don’t seem too willing to chase this market higher at current levels. A strong surge in the equities markets may bring some buyers into this market as appetite for risk increases, but it appears that there is more room to the downside. Watch for weakness in crude oil if equities begin a profit-taking break.
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