Fed Chairman Bernanke's Speech Will Make or Break Rate Cut Expectations

How Will The Markets React?

The markets will get a taste of consumption data for the beginning of the third quarter on Friday, as personal spending for the month of July will be released. The figure is anticipated to rebound 0.3 percent, in line with the improvement in advance retail sales and a sign that the labor market has thus far been strong enough to prevent a collapse in spending, softening the blow of a weak housing sector and a widening credit crunch. Even with a resilient consumer, the Federal Open Market Committee said on August 17th that “downside risks to growth have increased appreciably,” ramping up speculation they will cut interest rates next month and signaling that the worst of the economic slowdown is yet to come. Meanwhile, PCE Core, the Fed’s preferred inflation measure, is anticipated to edge up to 2.0 percent in July from a year earlier. Such a rise in price pressures would leave the central bank in a rock and a hard place, as they would be forced to contend with unstable financial markets, a slowing economy, and upside inflation risks. Nevertheless, the biggest market mover of the day will likely be Fed Chairman Ben Bernanke’s speech on housing and monetary policy at 14:00 GMT at the central bank’s symposium in Jackson Hole, Wyoming. Currently, Fed fund futures are pricing in a 25 basis point rate cut on September 18th, but any commentary that sways investor sentiment on coming monetary policy will shift market expectations and spark major price action. Traders should also keep in mind that Bernanke and other policymakers attending the conference could also be quoted over the course of the weekend, which may be reflected in the markets on Monday.

Bonds – 10-Year Treasury Note Futures

On Thursday, 10-year Treasury note futures continued to rally, hitting a high of 109-27 as the contracts continue to take aim on 110-00. Holding within an uptrending channel, a break below a supporting trendline near 109-00 will eliminate some of the bullish bias on the contracts, but the shaky nature of the equity markets are lending Treasuries decent strength. The biggest event risk for US government bonds is in Bernanke’s speech at 14:00 GMT, as traders anxiously await clues as to the Fed’s next policy move. Though it sounds counterintuitive, signs of a looming rate cut could send Treasuries plummeting as equity markets would rally.

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FX – EUR/USD

The EURUSD pair has remained range bound over the past few days, as mixed risk averse sentiment keeps US dollar traders on edge. Outside of the 1.3565 – 1.3685 range, the next level of resistance sits at the 78.6% fib at 1.3750, which could be the pair’s next bullish target. However, EURUSD faces massive event risk on Friday and the pair’s reaction may sound counterintuitive, as signs that the Federal Reserve will cut rates in September could send EURUSD higher as the US dollar has traded more as a safe-haven asset over the past two weeks and the data would help to assuage credit crunch concerns. Furthermore, the prospect of lower interest rates would limit the dollar’s attractiveness in terms of carry trade differentials. On the other hand, if Bernanke sounds as though he is content with leaving rate steady, equity markets could unravel as risk averse sentiment returns and pushes EURUSD down towards support at 1.3565, with sharp declines taking on 1.3485.

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Equities – Dow Jones Industrial Average

The Dow Jones Industrial Average eased back from a descending trendline (which is currently at 13,289) on Thursday, ending the day down 0.38 percent at 13,238.73. This trendline has blocked gains for the equity index since late July, and the Dow’s hesitance to break above this level signals that price could be moving lower to target the 200 SMA at 12,892 once again. On the other hand, a surge through that resistance level would aim to complete a 78.6 percent retracement of the decline from the August 17th high at 13,665, but this will only be possible if credit jitters subside. While US equities face event risk from Friday’s personal spending and core CPE releases, Fed Chairman Ben Bernanke’s speech at 14:00 GMT has the potential to set the tone for price action throughout the day. Traders will be looking for any clues to the bank’s next policy decision, and comments signaling a potential rate cut on September 18th could send the Dow skyrocketing. On the other hand, if Bernanke clearly avoids discussing the Fed’s next move or suggests that the bank will not cut interest rates, equities could sell off quickly and take the Dow down to test the 200 SMA at 12,892.

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