THE FEDERAL RESERVE

What might the Fed say as they wind down from a two-day meeting in Washington D.C. this afternoon?
 
Obviously it's too early to expect a rate rise from the FOMC and indeed they committee snuffed out such negative thinking just two months ago when the market last panicked. Bernanke said that we should expect the present over-easy era to remain intact for quite some time.

Bond rates are no better or worse than at the time of the last meeting and so it's hard to find room for the need to talk down the cost of borrowing. Inflation hasn't picked up appreciably, at least not to the extent that the Fed would find need to justify staying still on rates. Spare capacity and worker productivity confirm that the Fed's theory on inflation not being a problem is intact for now at the very minimum.
 
Tuesday's equity market meltdown was largely sourced from weakness in the Chinese economy. Global investor reaction to signs of reviving demand during the first half of the year is the cause of a sharp rally for equity prices. Now that the Chinese banking system has tightened the noose around the neck of lending analysts are now quite concerned that the recovery play might just be another asset bubble at an early stage.
 
Last Friday's employment report is a distant memory in the minds of bond traders. The least costly destruction of workers in 11 months was taken as a prompt that interest rate increases would soon happen. As we noted on Monday morning there are so many associated caveats contained around the report that traders are blowing off any chance of a rate rise. Besides the Fed isn't in the game of raising rates when employment statistics still measure job losses.
 
The U.S. dollar slipped just a little on Tuesday, largely owing to a rise in the value of the Japanese yen - if ever you need a sign of risk aversion, this is the ultimate barometer. The dollar mainly held its own against everything else except for the yen.
 
We noted in yesterday's commentary that the price of gold was falling alongside the prospects for the single European currency. Both edged higher by minimal amounts on Tuesday. The euro bought $1.4161 while gold was priced at $946 per ounce by the close. Neither event really taught us anything in the light of a slide in equity prices.
 
Because Chinese copper imports declined for the first time in six months, so too did the price of copper futures. The mixture of weakness in Chinese industrial production, imports and a worsening profile for banking earnings back in the U.S. was a lethal cocktail for investors. Right now it would appear that until investors hear otherwise either in terms of supportive data or from a bullish Federal Reserve, the path of least resistance is down.

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