Committee for a Responsible Federal Budget

MARKETWATCH: October 11 - 15

Oct 15, 2010 | Economics

Change is in the air, but plenty of uncertainty remains. As of mid-morning, the dust is still settling in U.S. and global markets as they take stock and adjust to today’s speech by Fed Chairman Bernanke in which he discusses the outlook for continuing US economic weakness (a demand shortage not a structural problem, he says) and what the Fed may well do about it (most expect the Fed to resume quantitative easing after its next meeting in early November, despite some continuing internal dissent among Fed policymakers).

Fiscal news has been on the back burner, other than attention-grabbing final official numbers for last fiscal year’s deficit.

With expectations about the Fed’s next moves dominating market moves, this week’s economic news has taken a back seat. We’ve had good news this week (September’s retail sales were strong – and stronger than expected; inflation remained very low in September – although some see this as the tip of the deflationary hole); and some disappointments (jobless claims are rising again; the University of Michigan consumer sentiment index headed down, contrary to expectations). But most importantly, throughout the week, critical problems in the mortgage markets, bubbling below the surface for awhile, popped out into the open. These problems continue to create serious bottlenecks in the economy and financial sector, and tend to limit the effects of normal policy prescriptions for recovery.
In an immediate reaction to the Bernanke speech, bond yields rose slightly (with the expectation of more quantitative easing increasingly priced in over the week). Mid-morning, bond yields on the benchmark 10-year bond were above 2.50 percent; and the thirty year bond was at 3.99 percent after briefly heading above 4 percent. The stock market has bounced up and down so far today, as addressing economic weakness was considered a positive, new data on the economy was of concern, and Friday profit taking always around. 
Domestic market developments are – as usual – all the more complex to understand because of global capital movements. Currency markets throughout the week have also been extremely active, as traders increasingly expected the Fed to further ease policy, in contrast to expectations that other central banks and fiscal authorities were tightening policy. The relative shift in global policy stances drove the dollar down rapidly against major currencies. A lower dollar will presumably help boost the U.S. economy through the export channel, although it can also raise import prices, which may or may not be passed on to consumers depending on market dynamics. Other countries also want the competitiveness of their exports supported by their exchange rate.