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Traders Hope Bernanke Sheds More Light on Fed's Next Move

Earlier in the week I questioned whether the Fed was out of bullets to combat the economic weakness threatening the U.S. economy. Having watched two dismal U.S. housing reports this week, I am now anxiously awaiting Federal Reserve Chairman Bernanke's outlook for the economy, his explanation for the Fed's recent decision to buy Treasury Bonds, and perhaps what the Fed could possibly have left in its toolbox to combat the threat of a double-dip recession.

No one is certain what Mr. Bernanke will talk about on Friday at the annual Fed gathering of central bankers in Jackson Hole, Wyoming. There is plenty to talk about since the economy has changed so much since the last Fed meeting earlier in the month. Based on his recent public statements, the Fed Chairman is likely to reiterate his concerns about persistently high unemployment and the extremely low inflation rate that is threatening to drive the economy into a deflationary scenario.

Because of the current fragile state of the economy, Mr. Bernanke's comments are likely to move the equity and debt market substantially. Since he doesn't have the evidence to paint a rosy outlook, he is going to have to stay the course by reiterating that the economy remains "uncertain" and cooling off or he may reveal a bleaker outlook.

There is no question based on current activity in the Treasury and equity markets that the Fed is moving the market. Its recent decision to buy Treasury Bonds, for example, has triggered a huge rally in this market prompting some to call it a "bubble". Equity markets have weakened since the last Federal Open Market Committee meeting because its move to buy Treasurys sent a message that perhaps the economy was weaker than previously thought.

I believe Bernanke has to speak about the economy with clarity and conviction. This may help to bring relief to those investors suffering from a "crisis in confidence". Bernanke also has to provide a little color about what the Fed is considering to do should the economic situation continue to worsen. One thing that he may shed some light on is whether the Fed is considering lowering the interest rate on reserve deposits banks have with the Fed. This may encourage banks to open up their lending windows a little.

This morning U.S. Weekly Jobless Claims fell more than expected, down 31,000 to 473,000. Although this is not a particularly great number, equity markets seem to like it, leading to a call for a higher opening. Treasury Bonds weakened on the news.

Yesterday the September E-mini S&P 500 made a daily closing price reversal bottom while the September Treasury Bonds were making a daily closing price reversal top. These trades were triggered by technical factors and an asset allocation play. There is no strong evidence that the moves will lead to a change in trend, but the charts indicate that stocks have room to rally and T-Bonds have room to correct.

 

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