Deja vu? Bernanke today and in June 2008

Several analysts – including Alan Ruskin at RBS, who I think is very sharp - are highlighting the parallels between Bernanke’s remarks today and his remarks on June 3 2008. The comments are very similar.

The main difference is that Bernanke warned about an erosion of inflation expectations in 2008 but described expectations as “stable” today – suggesting the Fed is further from raising rates now than it was then.

So far so spot on. But some in the market appear to be arguing that Bernanke’s words today are meaningless because a similar but stronger statement in mid-2008 did not end in action. I do not buy this.

My read of the history differs from the conventional wisdom. I think the Fed was getting genuinely uncomfortable about inflation risk in early June 2008 - but the emerging hawkishness was swiftly undercut by a change in the risk tide. This time the risk tide is flowing in the opposite direction, with falling risk aversion in financial markets.

Of course there are big differences that weigh on the other end of the scales: huge spare capacity, low current inflation and the aforementioned stability in inflation expectations today vs June 2008.

Against this, we are now in the early phase of a what increasingly looks like a sustained global upswing, in which pressure on commodity prices might intensify. In June 2008 the Fed thought we were in a global downturn in which pressure on commodity prices would eventually abate.

Moreover, the Fed has taken a lot of liberties with inflation expectations over the past year in the course of its unconventional credit easing and might be more uneasy if they started to move now than it was in June 2008.

Let’s be clear: I’m not suggesting that the Fed is going to raise rates any time soon, still less that it is going to do so in order to support the dollar and subdue commodity prices. I just don’t think the June 2008 parallel is a reason for treating Bernanke’s remarks today as all hot air.

I’m quoting below from Ruskin’s note to clients – hope that’s OK…

On June 03, 2008 (EUR/USD closed at 1.5445), Bernanke said the following: “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. Over time, the Federal Reserve’s commitment to both price stability and maximum sustainable employment and the underlying strengths of the U.S. economy–including flexible markets and robust innovation and productivity–will be key factors ensuring that the dollar remains a strong and stable currency.”

Compare the above with what Bernanke said today: ” The foreign exchange value of the dollar has moved over a wide range during the past year or so. When financial stresses were most pronounced, a flight to the deepest and most liquid capital markets resulted in a marked increase in the dollar. More recently, as financial market functioning has improved and global economic activity has stabilized, these safe haven flows have abated, and the dollar has accordingly retraced its gains. The Federal Reserve will continue to monitor these developments closely. We are attentive to the implications of changes in the value of the dollar and will continue to formulate policy to guard against risks to our dual mandate to foster both maximum employment and price stability. Our commitment to our dual objectives, together with the underlying strengths of the U.S. economy, will help ensure that the dollar is strong and a source of global financial stability.”

Conclusion: Some participants believe the 2008 statement was stronger than 2009, because of his reference to inflation expectations, and the risk that inflation could provoke tighter Fed policy. Certainly, the Fed’s perceptions of benign inflation expectations relative to 2008, will make interest rate policy less responsive to USD weakness now, relative to 2008.

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