Federal Reserve Confusion? – I don’t think so

Remarks from analysts this morning about Federal Reserve Bank of New York President William Dudley’s dovish comments on the state of the US economy mostly miss the mark in my view.

Dudley’s words stood out in stark contrast to those by other Fed officials last week and this week who have been sounding a hawkish tone and chattering about ending QE. To paraphrase some of his comments: The US economic recovery is ‘still tenuous’ and ‘far from the mark’ of the Central Bank’s goals of full employment and price stability, according to a report carried by Bloomberg this AM.

Dudley remarked that we must not be overly optimistic about the growth outlook”.

Almost as if on cue, the bond market sharply reversed course after selling off this morning on the payrolls number. The Dollar simultaneously began slipping off its session highs.

Analysts were quick to chime in stating that the comments reflect the confusion and lack of consensus within the Fed. I do not think so to be perfectly honest for the reason that I have stated previously here at this site.

If the Fed starts sounding hawkish in an attempt to keep the Dollar from collapsing through a major chart support level near 75 on the USDX, they cannot prevent the long bond from breaking down technically and thus commence a rise in long term interest rates which will bury what might be any signs of life in the comatose housing market.

If they sound too dovish then the Dollar will come under renewed selling pressure potentially setting up a serious move lower in the greenback as it remains sitting perilously just above technical price chart support.

The Fed is attempting to keep both the Dollar from collapsing lower (they do want a sustained and gradual move lower – not a crash) and the long bond from collapsing. This is the reason for the conflicting signals being put out.

The idea is to keep enough confusion and uncertainty in the market to prevent speculators from getting too aggressive either way. Once the specs become convinced the Fed might move to end QE, the bond market will be massacred.
If the market becomes convinced that the Fed will not only keep QE2 going but engage in a QE3, then the Dollar will be obliterated.

The Fed created its own box and now they can deal with it. One thing is certain – they are not going to be able to have their cake and eat it too. What they will eventually have to come to grips with is that they are going to either have to sacrifice the Dollar or sacrifice the long bond.


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