Fed to shine light on policy path

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The global economy is moving into a good old fashioned slowdown with the developed world's policy options limited and investors nervous, putting the spotlight firmly on US Federal Reserve Chairman Ben Bernanke in the coming week to point the way ahead.

Bernanke delivers his twice yearly update to lawmakers on Tuesday and Wednesday, beginning a day after the International Monetary Fund is expected to cut its global growth forecast when it releases the latest World Economic Outlook.

“I think investors are really going to be looking for what is it the Fed is willing to do, or can do, to try and stimulate growth,” Joseph Tanious, global market strategist at JP Morgan Asset Management said.

“But at the end of the day my opinion is that there is nothing it can do,” Tanious said.

Business sentiment indexes in Europe, slower growth in China and a run of weak US economic numbers have confirmed a loss of momentum in the world economy over the past two months.

Policy makers at central banks in Europe, Britain and Japan have all recently met and opted to stay on an easing path, while their governments all face fiscal constraints, leaving investors firmly in a defensive mood.

World equities are down about 2 percent this month, but are still up 2.1 percent for the year. While Citibank's World Broad Investment-Grade (WorldBIG) Bond Index is up 3.6 percent for the year to date, having gained around 1 percent so far this month.

FED QUESTIONED

The main questions most investors want Bernanke to answer are how close is the central bank to launching a third round of large-scale asset purchases (QE3), and what kind of other tools might it consider using.

The coming week see updates on the US inflation picture as well as data on housing starts and industrial production which should highlight the ongoing slowdown in the economy, adding to recent weak jobs numbers in paving the way for more easing .

Michael Metcalfe, head of macro strategy at State Street Global Advisers, believes the potential for a rapid fall in inflation below the Fed's current target has kept the prospect of further easing alive.

Metcalfe said an analysis of online prices compiled by PriceStats pointed to an inflation rate running at around 1.3 percent compared to the Fed's 2 percent target.

“This is also indicative of much lower level of economic activity in the economy and a rising deflation risk,” he said.

The minutes of the Fed's June 19-20 meeting, released in the past week showed a majority of policymakers were not yet ready to agree further stimulus measures but a small group were.

“Several participants commented that it would be desirable to explore the possibility of developing new tools to promote more accommodative financial conditions and thereby support a stronger economic recovery,” the minutes said.

EURO DEVALUATION

In Europe investors attention is on the single currency and its exchange rate with two of its major trading partners - the United States. and the UK.

This follows the recent decision by the European Central Bank to cut the rate if pays banks for their deposits to zero, which has released a flood of funds looking for a new home.

The move initially prompted banks to transfer nearly half trillion euros out of the deposit facility and back into their current accounts when it come into force on Wednesday, but the question on many people's minds is where they go next.

“What basically happened is (ECB President Mario) Draghi invited the market to sell the euro,” said Ned Rumpeltin, head of G10 FX strategy at Standard Chartered Bank.

“It probably doesn't happen in a stampede, but week after week you will start to see some of this money move elsewhere.”

The euro has fallen about 5.8 percent against the dollar so far this year, already exceeding losses chalked up in 2011, when it declined more than 3 percent.

Spain is also going to be in investors sights in the coming week when euro area finance ministers meet on July 20 to agree the final details of its banking sector bailout.

Madrid will also auction two-year, five-year and seven-year bonds on Thursday, as yields on its debt inch ever higher to unsustainable levels. - Reuters