Ben Bernanke did something very unusual this week. He mentioned the strength, or lack of, in the US Dollar. This is a big moment, whenever asked before, including in front of Congress et al, Bernanke has refused to comment.

Not any more, Bernanke has waded into the currency debate and not in a small way. In his speech delivered to the International Monetary Conference in Barcelona on the 3rd June, he dropped a very big clue about future US intentions. In the section titled “The Federal Reserve’s Policy Response” we got this:

• “In collaboration with our colleagues at the Treasury, we continue to carefully monitor developments in foreign exchange markets. The challenges that our economy has faced over the past year or so have generated some downward pressures on the foreign exchange value of the dollar, which have contributed to the unwelcome rise in import prices and consumer price inflation. 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.”
  

Only 2 things will make the dollar worth more, either interest rates rise making dollar and dollar assets attractive coupled with increasing demand or there will be less dollars or dollar assets available in the near future. Of course there is always the approach of combining both methods to help the dollar appreciate.
In Bernanke’s speech, the next point he made about Fed policy response was this:

• “Second, to improve market liquidity and functioning, we have taken a range of measures to ensure that financial institutions have adequate access to central bank liquidity.2 The resulting reductions in funding pressures, together with the increased confidence created by the assurance that backstop liquidity is available to eligible institutions, should help to promote an orderly resolution of current market dislocations. In recognition of the global nature of financial markets, we have also cooperated with other major central banks to ensure that central bank liquidity is deployed where needed.”

I don’t “do” coincidences. Was Bernanke reminding everyone that the current ability of the financial system to operate is down to the Fed and its facilities? Is this the beginning of a series of hints about the drawdown of such facilities; the ending of the liquidity flows?

If the availability of Fed provided liquidity, used to put into action the Eggertsson theory is now about to face a gradual restriction in the face of flat and then rising rates, the dollar and US Treasuries could attract a bid.

Bernanke has clearly linked the rise and fall in the dollar to commodity prices. The link is spelt out here, in the section titled “Outlook”:

• “Inflation has remained high, largely reflecting continued sharp increases in the prices of globally traded commodities. Thus far, the pass-through of high raw materials costs to domestic labor costs and the prices of most other products has been limited, in part because of softening domestic demand. However, the continuation of this pattern is not guaranteed and will bear close attention. Futures markets continue to predict–albeit with a great range of uncertainty–that commodity prices will level out, a forecast consistent with our expectation of some overall slowing in the global economy and thus in the demand for raw materials. A rough stabilization of commodity prices, even at high levels, would result in a relatively rapid moderation of inflation, consistent with the projections of Federal Reserve governors and Reserve Bank presidents for 2009 and 2010. Unfortunately, the prices of a number of commodities, most notably oil, have continued upward recently, even as expectations of future policy rates and the foreign exchange value of the dollar have remained generally stable in the past few months. The possibility that commodity prices will continue to rise is an important risk to the inflation forecast. Another significant upside risk to inflation is that high headline inflation, if sustained, might lead the public to expect higher long-term inflation rates, an expectation that could ultimately become self-confirming.”
  

I apologise about the large quotations but this is quite an important moment for the Fed, Bernanke and commodities. It is also the closest you will get to Bernanke acknowledging that the amount of dollar and dollar assets such as short end US treasuries do affect price inflation.

Notice he addresses commodity prices as a function of relative dollar value and the acknowledgement that a US recession will not moderate prices alone. More importantly he talks about inflation expectations becoming unhinged causing second round effects (higher wage demands – surely an increase in monetary supply?).

This is the second phase of the Eggertsson theory in full flow, inflation expectations have been raised and corporate and public USA has reacted accordingly. With the yield curve now steep enough to allow the short end to rise (which it has been doing) now is the time for the “credible” Fed inflation fighting rhetoric and action to become fact.

Rates will be going higher, soon. Liquidity will be drawn down as soon as the repairs are made to the balance sheets and the capital reserves of the Broker/Bank complex. Rising rates will encourage an inward investment in dollar assets, helping to control the long end of the bond market.

Its time to start looking for dollar based opportunities.

Commentary by Mick Phoenix

on behalf of CA Letters

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it. The views in the article are for informational purpose only.