Big Ben’s Bluff

Macro traders who bet against Ben Bernanke’s tough talk the other week will have begun to make money. Fed fund futures are now discounting only 50bp of tightening in 2008 compared with 75bp after Billyboy opened his mouth to try and talk down oil and stabilize the dollar.

Still there is probably more money to be made on this trade. GREED & fear continues to believe that the Fed will not raise interest rates at all in 2008. This view is partly based on an empirical observation of Bernanke’s behaviour as Fed chairman thus far. He starts to pose as the guardian of anti inflationary resolve when stock markets rally, just as they did in November-December last year and then again in March-May this year. These rallies, led as they are by the financial stocks, naturally breed hopes that the “credit crisis is over” and Billyboy, being human, wants to believe them too. But as the diligent student of the Great Depression that he undoubtedly is, he turns nervous again when the equity market action turns decisively negative. And the action in the various US financial indices can only be considered very negative in the deflationary sense. Clearly, the last thing US financial stocks need in this context is higher short term interest rates.

Let’s hope the markets start to recover soon!

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