The Overnight Report: What Fed Exit?

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By Greg Peel

The Dow closed up 52 points, or 0.3%, while the S&P gained 0.2% to 1669 and the Nasdaq added 0.2%.

Fed chairman Ben Bernanke will make a regular testimony to Congress tonight, but it is probably already clear what he will say with regard to the US economy and the central bank’s accommodative QE policy. His lieutenants were out and about making speeches last night which, quelle horreur, reconfirmed the Fed’s last monetary policy statement.

Wall Street was stronger from the opening bell, but before 11am the sellers had moved in to send the indices back to the flat line. It was at this point St Louis Fed president and FOMC member James Bullard was making a speech in Frankfurt, in which he suggested the Fed should continue with its current bond-buying program and adjust the rate of purchases based on incoming data. “Adjust”, not “reduce”. He dismissed the idea of the Fed doing nothing as this would threaten a Japanese-style deflationary environment.

At that point Wall Street rallied once more.

Early in the afternoon, New York Fed president and FOMC member William Dudley made a speech on home soil, to the Japan Society funnily enough, in which he said he is not sure which way the Fed will adjust its bond purchases given the uncertain economic outlook. He suggested that evidence of a substantial improvement in the labour market would be needed before the pace of bond purchases could be reduced, and he also made note of the “fiscal drag” that had to be overcome for such improvement to be evident.

In the US, as is the case in Australia, the central bank is fighting not only a fragile economy, but the counter-effect of government budget tightening. Dudley also noted that when the time does come to ease off on bond purchases, the Fed will need to be very careful about not causing market disruption.

In other words, the Fed is not going to let bond prices fall out of bed. Or let Wall Street fall out of bed.

After all the hawkish talk the last couple of weeks of a Fed wind-back coming as early as September, we are now back where we were at the beginning of the month. Depending on the economic data, the Fed will either reduce or increase bond purchases as it sees fit for the foreseeable future. QE infinity.

Now we can all get some sleep.

Bullard’s speech affected another kick up in the indices, sending the S&P 500 into blue sky once more. Buying faded over the rest of the session nevertheless, and the S&P closed off its highs.

There was little overall movement on other markets, with the exception of gold. Having jumped up over US$30 on Monday night as the dovish Fed talk emerged, last night’s speeches were not enough to sustain a further rebound and gold fell back US$17.30 to US$1376.50/oz. The US dollar index is up a tad to 83.82 and the Aussie is steady at US$0.9804. The US ten-year bond rate fell two bips to 1.94%.

Base metals were weaker in London but barely so, while the expiry of the NYMEX June delivery contract was largely blamed for a US98c fall in West Texas crude (July delivery) to US$95.95/bbl and a US$1.18 fall in Brent to US$103.62/bbl. Brent is already trading a July front month.

For the first time in quite a while, spot iron ore actually rose in China, up US40c to US$123.40/t.

The SPI Overnight lost 5 points.

The Bank of Japan holds a policy meeting today, but if it ain’t broke, why fix it? The release of Japan’s April trade balance will provide some clue as to what impact the significantly weaker yen is having on exports. Bernanke will testify to Congress at the same time the minutes of the aforementioned last Fed policy meeting are released, and presumably there will be no contradiction.

Westpac releases its monthly consumer confidence survey locally today, while Myer ((MYR)) will report March quarter sales numbers.

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