Following the initial reaction in the market in favor of the USD on account of Bernanke not offering any new stimulus, we saw a dramatic reversal, and whipsaw in the USD majors.

The EUR/USD after dipping to 1.4325, rose as high as 1.4470, as stocks also rebounded and despite the disappointment that investors and traders may have had with Bernanke, they didn't show it in the market. The GBP, AUD and CAD were also strong gainers following the speech. This runs counter to some of the expectation that no stimulus would be a risk-averse event, but we may be seeing some buy the rumor, sell the fact type action here, though it seems to be in reverse, sell equities on the rumor, but then buy on the fact.

width=384Perhaps the fact that Bernanke did not bring out the big guns shows that he believes things aren't as bad as some believe, and we do know that his still holds his stimulus options that he has outlined in the past, which includes more easing if needed.

The market also likely re-focused more on the easy accommodative policy of the Fed going forward, even if it doesn't mean more easing yet.

What may be the most important take away therefore was the comments that Bernanke had in regards to fiscal policy and politicians.

He cast some stones at Washington by arguing that the debt ceiling debt harmed the economy but also made a plea that some type of fiscal stimulus is needed to help get the economy going, even as fiscal consolidation is needed in the long term. He made similar comments during his appearance in front of the Senate and House.

Bouts of sharp volatility and risk aversion in markets have recently re-emerged in reaction to concerns about both European sovereign debts and developments related to the U.S. fiscal situation, including the recent downgrade of the U.S. long-term credit rating by one of the major rating agencies and the controversy concerning the raising of the U.S. federal debt ceiling. It is difficult to judge by how much these developments have affected economic activity thus far, but there seems little doubt that they have hurt household and business confidence and that they pose ongoing risks to growth.

Finally, and perhaps most challenging, the country would be well served by a better process for making fiscal decisions. The negotiations that took place over the summer disrupted financial markets and probably the economy as well, and similar events in the future could, over time, seriously jeopardize the willingness of investors around the world to hold U.S. financial assets or to make direct investments in job-creating U.S. businesses. Although details would have to be negotiated, fiscal policymakers could consider developing a more effective process that sets clear and transparent budget goals, together with budget mechanisms to establish the credibility of those goals. Of course, formal budget goals and mechanisms do not replace the need for fiscal policymakers to make the difficult choices that are needed to put the country's fiscal house in order, which means that public understanding of and support for the goals of fiscal policy are crucial.

He made it quite clear that monetary policy can not come to the rescue this time, that the Fed can't do all the heavy lifting here and that it will be up to fiscal policy to help boost growth.

Under these unusual circumstances, policies that promote a stronger recovery in the near term may serve longer-term objectives as well. In the short term, putting people back to work reduces the hardships inflicted by difficult economic times and helps ensure that our economy is producing at its full potential rather than leaving productive resources fallow. In the longer term, minimizing the duration of unemployment supports a healthy economy by avoiding some of the erosion of skills and loss of attachment to the labor force that is often associated with long-term unemployment.

Notwithstanding this observation, which adds urgency to the need to achieve a cyclical recovery in employment, most of the economic policies that support robust economic growth in the long run are outside the province of the central bank. We have heard a great deal lately about federal fiscal policy in the United States, so I will close with some thoughts on that topic, focusing on the role of fiscal policy in promoting stability and growth.

Of course the opposite conversation is going on in Washington in which the big rave is cutting government spending (and therefore aggregate demand) and there is very little appetite among the Tea Party crowd for ANY government spending, not to mention anything that can help Obama in his chance at reelection. We have seen that the Tea Party was ready to have the US default, so slow growth and criticism from Bernanke (which they will likely wear as a badge of honor in any case) will change their sentiment on that.

width=363Bernanke's plea for help from Washington sets up President Obama's speech on the economy and jobs (due September 6th) quite nicely as he will try to unveil some steps to help the labor market and the overall economy - including extension of payroll tax, a possible investment bank to fund infrastructure projects, and other things that can help such as passing trade agreements.

As a fresh reminder of U.S economic weakness and why the Fed will hold off on rate hikes all next year, it was announced Friday the U.S. economy grew a meager 1% and corporate profits moderated in the April-July period amid weak consumer spending, stalled exports and a smaller buildup in inventories.

Nick Nasad

Chief Market Analyst