Bernanke’s 180

The ongoing struggles at Fannie Mae and Freddie Mac also represent an additional hurdle for U.S. Federal Reserve Chairman Ben S. Bernanke. The Fed chair was already struggling to balance sluggish growth and soaring inflation, and now volatility in the credit markets has flared up precisely as the Fed was starting to telegraph a rate increase.

Last month, Bernanke said the risks of a “substantial downturn” had diminished and vowed to “strongly resist” mounting inflationary pressure. Many traders predicted the Fed would raise its benchmark-lending rate as early as August. Wall Street had priced in three interest rate rises from the current level of 2% to 2.75%, according to the Times Online.

But now, those same traders don’t think Bernanke will move before October at the earliest.

“Bernanke has changed his tune,” Kevin Logan, senior economist at investment bank Dresdner Kleinwort Ltd. in New York told the Times. “In June, he said that he didn’t think it was all that bad. Now, six weeks later, he is saying that there are significant downside risks. He has basically been forced to face the data that has come out over the last six weeks, which shows that the U.S. economy is deteriorating.”

In prepared testimony before the Senate Banking Committee, Bernanke said yesterday that the economy “continues to face numerous difficulties, including ongoing strains in financial markets, declining house prices, a softening labor market, and rising prices of oil [and] food.”

“Many financial markets and institutions remain under considerable stress, in part because the outlook for the economy and thus for credit quality, remains uncertain,” he added. “In general, healthy economic growth depends on well-functioning financial markets. Consequently, helping the financial markets to return to more normal functioning will continue to be a top priority.”

Inflation’s Open Invitation

With inflation no longer the predominant priority for the Fed, the dollar will continue to weaken and inflation will engulf the economy.

“The Fed is downgrading some of their economic outlook for the medium term,” Carl Forcheski, vice president on the corporate currency sales desk at Societe Generale SA (OTC: SCGLY) in New York, told Bloomberg. “That translates to a continued postponement of any thoughts of rate hikes,” thus weakening the dollar.

The greenback hit a record low of $1.6038 against the euro yesterday (Tuesday), after the Labor Department reported that inflation at the wholesale level jumped 1.8% in June, after climbing 1.4% in May. Consumer prices likely climbed 4.5% in June, according to economists surveyed by Bloomberg.

According to the Fed’s most recent economic projections inflation will be higher this year than previously thought, with prices rising as high as 4.2%. But with financial markets racked with uncertainty, it’s hard to tell how much further the dollar has to go.

“The reality is the U.S. housing market and credit squeeze haven’t hit bottom yet,” Takuma Kurosawa, global markets treasurer at HSBC Bank PLC (OTC: HBCBF), told Bloomberg. “That’s discouraging investors from holding dollar assets.”

Paul Robson, a currency strategist at Royal Bank of Scotland Group PLC (ADR: RBS) told the International Herald Tribune that the euro would hit $1.62 in the “near term,” but a sharp rise to around $1.65 would spur intervention by global central banks to support the greenback.

The diving dollar did little to save foreign markets, however, as fears about the U.S. economy infiltrated global markets.

In London, the FTSE 100 index fell 2.4%, while the Dow Jones Euro Stoxx 50 index dropped 2.3%. The CAC 40 in Paris and the DAX in Frankfurt each lost roughly 2%.

In Asia, the Hang Seng index in Hong Kong fell 3.8%, taking its loss for the year to 24%, while the Nikkei 225 stock average fell nearly 2%.

Source: Turbulent Credit Markets and Inflation Undermine Attempts by Paulson and Bernanke to Bolster Investor Confidence 

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