Cheap Talk on Dollar Rally.

It sounds eerie to hear a top Federal Reserve officla talk about mounting inflation based on his conjectures. We then have Bloomberg flash an article (see below) that the Federal Reserve might raise interest rate to promote a rally in the value of dollar based on pure conjectures. It is perhaps a wisful thinking. Or, maybe, officials are raising expectation on rising inflation so that market participants will believe that the real inflation in prices will take place, based on the theory of this year's Economics Nobel Memorial Prize winner. Rallying the dollar is all that the Federal Reserve wants, not raising the rate of interest, through cheap talks. But market participants have stopped noticing cheap talks. In fact some other Fed officials have conceded lately that such talks are no longer credible for markets. Capital markets are mutely bidding down long-term bond yields because there is excessive money supply in the system (thanks to Federal Reserve) compared to demand for credit due to anticipated recession and deflation.

Sankarshan Acharya

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Dollar May Climb as Fed Officials Emphasize Inflation Concerns

By Chris Young and Kosuke Goto

Nov. 7 (Bloomberg) -- The dollar may strengthen for a fifth day against the yen after Federal Reserve officials said the benchmark interest rate should be kept unchanged or even raised to curb inflation.

Fed Bank of Cleveland President Sandra Pianalto endorsed holding the overnight lending rate on loans between banks at 5.25 percent as ``some risks remain'' on inflation. Chicago Fed Bank President Michael Moskow yesterday said the central bank may need to raise borrowing costs to curb rising prices.

``Fed comments will be supportive of the rally we've seen in the dollar,'' said John Kyriakopoulos, a currency strategist at National Australia Bank Ltd. in Sydney. ``Officials are downplaying the likelihood they'll be cutting rates soon.''

The dollar traded at 118.17 yen at 9:10 a.m. in Tokyo from 118.31 in New York yesterday and may rise to 119 this week, Kyriakopoulos said. The U.S. currency was at $1.2726 per euro compared with $1.2723. Should the euro close below its 100-day moving average of $1.2706, it will target the 200-day moving average of $1.2514, he forecast.

``I fully expect the economy to grow at a moderate, but sustainable pace'' Pianalto also said in a speech on monetary policy and the economic outlook in Pittsburgh yesterday. ``Holding the rate steady is giving us time to assess the full impact of our 17 rate increases and to see how economic conditions unfold.''

Interest-rate futures prices indicate an 11 percent chance the Fed will lower the overnight rate on loans between banks at its March 21 meeting. Traders saw 100 percent odds of a rate cut at that meeting on Nov. 1.

``The U.S. economy is making a soft landing, diminishing concern over a rate reduction,'' said Seiichiro Muta, director of foreign exchange at UBS AG in Tokyo. ``The markets are becoming more readily reactive to hawkish comments by Fed officials, pushing up the dollar'' to 118.50 yen this week.

`Lightly Dressed'

``My current assessment is that the risk of inflation remaining too high is greater than the risk of growth being too low,'' Moskow said during a speech in Chicago. ``Thus, some additional firming of policy may yet be necessary to bring inflation back to a range consistent with price stability in a reasonable period of time.''

He will be a voting member of the central bank's rate- setting committee next year.

Fed Bank of San Francisco President Janet Yellen didn't comment on the economic outlook or the path of interest rates in the text of her remarks at the university's Center for the Study of Democracy. Yellen and Pianalto are voting members of the Federal Open Market Committee.

Futures traders decreased bets the yen will decline against the dollar, figures from the Washington-based Commodity Futures Trading Commission showed on Nov. 3.

The difference in the number of wagers by hedge funds and other large speculators on a decline in the yen compared with those on a gain -- so-called net shorts -- was 59,600 on Oct. 31, compared with record net shorts of 137,290 a week earlier.

``Investors are now lightly dressed with yen short positions,'' said Muta at UBS. ``They will likely pile up yen shorts again.''

To contact the reporter on this story: Chris Young in Sydney at cyoung12@bloomberg.net ; Kosuke Goto in Tokyo at kgoto2@bloomberg.net

Last Updated: November 6, 2006 19:12 EST

Sankarshan Acharya