A year on, Bernanke earns credibility in FX market
Monday, February 12, 2007 2:31:18 PM (GMT-06:00)
Provided by: Reuters News
By Nick Olivari
NEW YORK, Feb 12 (Reuters) - Currency investors have grown far less skittish about Ben Bernanke's handling of U.S. monetary policy over the past year, and a gauge of that confidence suggests his hard-fought credibility may not fade anytime soon.
Filling the shoes of Alan Greenspan, who presided over the Fed during the longest economic expansion in U.S. history, was always going to be a tough proposition. Close scrutiny was guaranteed and critics were quick to harp on any mistakes.
After a few early errors Bernanke has now proved himself after one year in office, foreign exchange analysts and traders said. So much so that, in his next appearance before Congress scheduled for this week, implied volatility in the currency options market is near historic lows, having fallen sharply in the last year.
While Bernanke certainly is not the only factor suppressing volatility, seen as a guide to spot market price direction over a specified time, his rising credibility has helped.
"Bernanke has exceeded most analysts' expectations by rapidly earning market credibility and his inflation fighting credentials," said Michael Woolfolk, currency strategist at the Bank of New York.
Bernanke was initially expected to be more dovish than Greenspan, Woolfolk said. He proved otherwise by continuing to raise interest rates in the first few months of his tenure and then refusing to cut them in the second half of 2006 despite a soft patch in economic growth and the housing market.
Euro/dollar one-month volatility has eased back to 4.83 percent on Feb 9, according to Reuters historical volatility data, less than half the 10.22 percent on Jan. 31, 2006, the day Bernanke was sworn in. Dollar/yen one-month volatility was at 5.86 percent on Friday compared with 9.32 percent just prior when Bernanke took up the post.
Volatility tends to fall when the market expects a currency to trade in a range, suggesting to some investors that Bernanke's inflation fighting credentials and the outlook for interest rates will promote a stable currency.
ROUGH PATCH
It has not all been smooth sailing, however, despite no major fiscal crises.
Last May, after just four months in office, CNBC anchor Maria Bartiromo broadsided financial markets and Bernanke by revealing the Fed chairman had told her he was disappointed with some investors' view that he was dovish on inflation.
The conversation took place at the annual White House correspondents dinner, which most attendees treat as off the record. Bartiromo's bombshell on live television sparked speculation over whether the Fed would pause its then two-year interest rate increase campaign or raise further.
The episode is viewed as the largest misstep of his first year, but he was no stranger to controversy before then.
In November 2002 he referenced a helicopter dropping money as an economic metaphor for fighting deflation. He had also noted that the U.S. could create inflation by printing money. Neither statement endeared him to financial markets.
Now all seems forgiven, thanks to what has so far been a correct assessment of the U.S. economy and how to handle it.
"The decision to halt 17 months of rate increases in August 2006 appears now to have been judged nicely, housing has slowed but not collapsed; consumer spending has barely fluttered," said Joseph Trevisani, chief market analyst at FX solutions in Saddle River, New Jersey.
"If Mr. Bernanke had been wrong his credibility would have been ruined before he began," Trevisani said. "But he was correct, and the markets forgive anything if you are right."
GREENSPAN MYTH
Part of the Greenspan legend was his longevity in the post. With 18 years and five months and 20 days, Greenspan was the second-longest serving Fed chairman in its 93-year history.
That still gives Bernanke time to make some mistakes, and traders emphasize that he has yet to be tested by potentially cataclysmic events such as the collapse of hedge fund Long Term Capital Management or the Russian debt default. Both 1998 events roiled world financial markets.
The dollar has mostly declined in the time that Bernanke has been in charge, but the slippage has been more orderly than chaotic thanks to his firm stand on inflation. The euro is up 7.2 percent, while sterling has gained 10.1 percent.
His latest appearance before Congress last month added further to market confidence. Bernanke bluntly warned the U.S. Congress that failure to deal with budget strains posed by an aging U.S. population could lead to serious economic harm.
"Last year, from the first missteps with Bartiromo, I thought he was out of his depth," said Craig Russell, chief marketing strategist at IKON Global Markets in Chicago. "But the Bernanke I saw on Jan 18 was calm and self assured. I was wrong about the man."
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