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Fed Doves Fly Tight Formation

Last updated 10/1/2012 4:42 PM EST (GMT -5) 0 Comments - Add your comment

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Neal Gilbert

Technical Analyst, GFT

Follow @FXexaminer

Happy Global PMI Day!

On a day where many investors were searching the wires for some bad news to give them a reason to sell, there was nothing but good news to frustrate their inkling. Judging from the extreme sell off that occurred at the end of last week, many market participants were just waiting for that other shoe to drop. Rumors proliferated about Spanish downgrades, dismal Spanish bank stress tests, and Spanish riots that prompted most risk to head for the exits. However, the downgrade never came, the stress tests weren’t as horrible as rumored, and the riots became old news to everyone but the guy who only gets his news from the Sunday paper. A rebound was in order, and the global Manufacturing PMI reports were just the thing to get the ball rolling.

The Manufacturing PMI reports are produced by the Markit Group and according to their literature are designed to “provide purchasing professionals, business decision makers and economic analysts with an accurate and timely set of data to help better understand industry conditions.”

Expectations for what the reports would say were varied across the globe, but the largest interest was centered on the three largest economies in the world: China, the European Union, and the United States.

One of the never-ending themes in finance is if China’s economy is going to slow down, and if it does, will it be a hard or soft landing. Report after myriad report is dissected to determine what it means to the potential Chinese landing zone. Today’s PMI showed a 49.8 print that matched expectations, but was still below the 50 boom/bust level for the second month in a row. A report under 50 indicates that the economy is in contraction mode, but clearly is not that far away from growth. 

Nonetheless, the sub 50 report encouraged investors to sell risk assets during a very uneventful Asian trading session that lacked the liquidity of China and Australia due to the Golden Week and Labour Day holidays respectively.

When it was Europe’s turn to release the Manufacturing PMI data, expectations were lessened by more than a few notches. If Spinal Tap can turn the volume up to 11, expectations for Europe could get turned down to -1. So despite numerically awful results for Italy (45.7), France (42.7), Germany (47.4), and the EU as a whole (46.1), they all beat the expected results therefore creating a rally that lasted in to the North American trading session.

The US releases of Manufacturing PMI were mixed as there were two results. The Markit release missed expectations of 51.5 by showing a 51.1 while the ISM Manufacturing PMI beat estimates of 49.7 to provide a 51.5. Risk was again emboldened as markets again began to rally before falling off for the duration of a light trading afternoon.

As we head in to the evening hours of North America, the specter of Moody’s potentially downgrading Spain is still looming and could weigh down on the aggressiveness of the market as another holiday filled Asian session stands ready to begin their Tuesday. With the lack of liquidity from that region, the current trend may continue as my colleague Matt Weller pointed out earlier today.

Fed Doves Fly Tight Formation

Two of the more interesting and influential policy makers at the Federal Reserve made appearances today to discuss what the Fed is doing now and will be doing in the future. Chicago Fed President Charles Evans appeared on CNBC, while Fed Chairman Ben Bernanke made a speech in Indianapolis titled, “Five Questions about the Federal Reserve and Monetary Policy.”

Evans has long been known as one of the most dovish members of the Federal Reserve. Although he is not currently a voting member, his ideas have gained traction in Fed circles, and it is believed that his ideas to tie monetary policy decisions directly to unemployment is the backbone to the Quantitative Easing program currently under operation.

In Evans’ appearance he indicated that he would have gone even further down the rabbit hole and provided more stimulus than they actually did. He also indicated that higher interest rates would be great for savers, but a growing economy would be more beneficial to them as well as everyone else.

This is an argument that often gets lost in the Fed bashing that many like to engage in (including your author occasionally). Most people who save are not just putting money in to a savings account or buying T-bills, we are also putting our money in to 401(k) accounts and IRAs that are directly tied to the stock market. If the economy improves, our savings in that field increase, and as a consequence of that improvement, the Fed would likely tighten monetary policy by bringing up interest rates. Therefore, in order to help out all savers, the Fed is going to extraordinary lengths to attempt to get the economy back to full employment. It actually makes sense when explained in that way…go figure.

Bernanke’s appearance was more of the traditional speech in front of an economic club where he went about explaining why the Fed did what it did. And in a similar manner to Evans, discussed how the policy they are employing will help everyone in the long run. Bernanke also went about debunking some conspiracy theories about the Fed that I’m sure he loves doing in much the same way that I love dropping a hammer on my toe.

One of the more poignant points of his debunkification (I just made up that word), he brought up the criticism that the Fed is a closed organization that meets in secret to plot their world domination Montgomery Burns-style. His explanation was quite convincing:

“One of my principal objectives as Chairman has been to make monetary policy at the Federal Reserve as transparent as possible. We promote policy transparency in many ways. For example, the Federal Open Market Committee explains the reasons for its policy decisions in a statement released after each regularly scheduled meeting, and three weeks later we publish minutes with a detailed summary of the meeting discussion. The Committee also publishes quarterly economic projections with information about where we anticipate both policy and the economy will be headed over the next several years. I hold news conferences four times a year and testify often before congressional committees, including twice-yearly appearances that are specifically designated for the purpose of my presenting a comprehensive monetary policy report to the Congress. My colleagues and I frequently deliver speeches, such as this one, in towns and cities across the country.”

So while the Fed will never be able to convince everyone that they are looking out for the good of the economy, they provided a unified front today that went a long way toward making their difficult role more understandable for the non-economist. 

Looking Forward

Tonight will be a very interesting night for at least one country in the Asian region as the Reserve Bank of Australia will be making a monetary policy decision. One thing the RBA has never been afraid to do is be proactive in their monetary policy. Whether it be cutting when they see potential for a slowdown, or rising when the economy heats up, they are very aggressive in their actions.

With other central banks around the world introducing new stimulus measures, the RBA may be in a unique position in that they may not have to do much of anything in the near future. The Fed’s QE∞ program should drive up commodities (good for Australia), China’s infrastructure plans should increase demand for raw materials (good for Australia), and plans to bolster economies in Europe and Japan by the European Central Bank and Bank of Japan respectively should help Australian growth as well. Unfortunately, the one bugaboo about all of this easing is that the AUD will likely continue to gain strength, something that the RBA isn’t too fond of.

Therefore, my expectation is that the RBA will make no changes to their overnight rate, but they will mention the high value of the AUD and that they will continue to be monitoring it for potential future policy action.  Therefore, the price action may not be extreme, but could put downward pressure on the AUD/USD down to 1.03 psychological support.

For more intraday analysis and trade ideas, follow me on twitter ( @FXexaminer ) and/or Facebook (FX Examiner).

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About The Author

Neal Gilbert, an avid follower of the markets, began working at GFT in 2006, educating new and experienced traders in an easy-to-understand manner. His focus has been teaching common technical indicators, risk management, and sharing his favourite trading strategies. His Braving the Rapids strategy guide can be found on GFT’s website.

Neal conducts live webinars throughout the day, including his” Long and Short of It,” which is a Fundamental Live Market Analysis webinar centred on key economic releases. He also conducts webinars in Basic and Advanced Technical Indicators, Volatility and Risk Management, Trader’s Edge, and Fibonacci Trading and Theory.