Despite conflicting implications on the economic outlook, the series of events happened yesterday was bullish for gold which surged to a record high of 1586.9 before settling at 1585.5, up +1.49% (the contract advanced further to 1590.8 in Asian session today). Market sentiment was buoyed as investors viewed Fed Chairman Ben Bernanke's testimony before the House as a signal for further stimulus measures. Wall Street gained with the DJIA and the S&P 500 Index rising +0.36% and +0.31%, respectively. Oil prices soared with the front-month WTI and Brent crude contracts adding +0.64% and +0.87%, respectively. Moody's said that it placed US on review for downgrade regarding the debt ceiling issue. This was, however, upstaged by Bernanke's comments that tax receipt will be used for debt payment first to avoid a default. Sovereign crisis in the Eurozone lingered. Fitch downgraded Greece's rating to CCC, from B+, as the EU/IMF failed to agree on a new and credible funding program for the country. Meanwhile, the agency believed Italy would cope with the rise in bond yields.
Bernanke's testimony was under the spotlight and market reactions immediately after his speech signaled the market viewed that the Fed would implement further expansionary measures if growth slows further. In his speech, the Chairman said that 'the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support' and the Fed is 'prepared to respond should economic developments indicate that an adjustment of monetary policy would be appropriate'. Concerning possible measures, the Chairman suggested that the central bank could 'provide more explicit guidance about the period over which' the Fed funds rate and the balance sheet 'would remain at their current levels'. The Fed could also 'initiate more securities purchases' and 'increase the average maturity' of the holdings. Moreover, the Fed could also 'reduce the +25 bps of interest it pays to banks on their reserves, thereby putting downward pressure on short-term rates more generally'.
The Fed, however, did not appear to worry much about recent weakness in economic data, policymakers believed the slowdown is temporary, mainly due to rising gasoline and food prices, as well as disruption in auto production. Growth will return in the second half of the year as 'stabilization in the prices of oil and other commodities should ease the pressure on household budgets, and vehicle manufacturers report that they are making significant progress in overcoming the parts shortages and expect to increase production substantially this summer'.
Our economists expect the Fed will continue monitoring upcoming economic data and take a 'wait-and-see' mode on monetary stance. While the Fed believed that recent surge in inflation is temporary, it has risen to the upper range of the central bank's comfort zone. Meanwhile, growth has been sluggish and unemployment rate climbed again in June. The Fed is indeed torn between tightening and easing. 'Doing nothing' for the time being, is probably what the Chairman described as 'prudent planning'.
Whether an agreement on raising the debt ceiling can be reached by August 2 remains a mystery. Moody's showed its concerns over the issue by placing US's debts on review, saying a downgrade of that Aaa rating is possible. The agency said that there are 'rising possibilities' that the debt ceiling will not be raised on a timely basis and 'there is a small but rising risk of a short-lived default'. This is a real concern but investors were soothed as Chairman Bernanke pledged that tax receipt will be used to debt payment first to avoid a default.
Indeed, rating agencies have playing an active and important role in triggering bond yields and market sentiment. In the Eurozone, sovereign debt concerns persisted. Fitch downgraded Greece's rating by 3 notches from B+ to CCC (1 step above default), making it more in line with other rating agencies (Moody's downgraded Greece to Caa1 on June 1 and S&P's downgraded it to CCC on June 13). Fitch said its new assessment 'encapsulates substantial credit risk and acknowledges that default is a real possibility'. On the other hand, Fitch stated its confidence in Italy, saying the country 'is on track to meet this year's budget target and the additional measures recently announced strengthen the credibility of the goal of a balanced budget by 2014'.
The market today will turn to US' retail sales, initial jobless claims and PPI data for more indications on the recovery outlook. Meanwhile, final estimates for Eurozone's June inflation will also be released.
