Federal Reserve Chairman Ben Bernanke said this morning that rates are “well positioned” to handle inflationary threats to the economy as well as sustained economic weakness. Markets are interpreting this news that rate cuts are over, and rate markets are trading higher on the news this morning. The ‘well positioned’ comment didn’t move markets as much as Bernanke’s comments on the dollar:
The downward pressures on the dollar “have contributed to the unwelcome rise in import prices and consumer price inflation,” he said.
“We are attentive to the implications of changes in the value of the dollar for inflation and inflation expectations and will continue to formulate policy to guard against risks to both parts of our dual mandate, including the risk of an erosion in longer-term inflation expectations.”
Bernanke has never put such emphasis on either the Fed’s attentiveness to the dollar’s decline or the inflationary dangers it poses.
Normally Bernanke and the Fed will defer to Treasury Secretary Henry Paulson on currency matters, so the fact that Bernanke spoke of inflationary pressures of the dollar is significant. And he’s right because, as we’ve been saying, Fed cuts hurt an already weak dollar and this can push rates up in two ways. First, a weak dollar usually means Foreign buyers back off U.S. investments. When they dump stocks, it’s bad economic growth overall. When they dump bonds, it has a direct upward impact on rates (since bond yields, or rates, rise when bond prices drop). Second, a weak dollar raises prices for imports which is inflationary, and the Fed’s job is to hike rates if inflation becomes a problem.