Bulls Put Faith in Bernanke

To wit, the homebuilders fared poorly Monday. The Philadelphia Homebuilders Index fell 1.1% on the day, as D.R. Horton(DHI Quote), KB Homes(KBH Quote) and Lennar(LEN Quote) each fell 2% or more.

One might think that the dismal new-home sales data would cause the Fed chairman to express more concern about the economy. But a week after moving in a dovish direction, he is clearly not interested in succumbing to legislative pressure to cut interest rates. He is still expressly concerned about inflation. So Bernanke is likely to reassure lawmakers and the country that the subprime meltdown has not spilled over into the broad economy. This way, he maintains his just-left-of-a-tightening-bias stance.

If he suggests anything to the contrary, traders would surely assume the Fed is acknowledging some kind of disaster. There is a slim chance that Bernanke will come out extra-hawkish to let the markets know they interpreted last week's FOMC statement incorrectly. But, given Monday's words from Chicago Federal Reserve President Michael Moskow, that is unlikely.

In a speech in Beijing, Moscow said the housing market "is in the process of stabilizing, and that by the second half of the year, housing will start to pick up again." On the question of spillover from the subprime segment of the market, he said, "There's no evidence of that happening so far. I think it's a very low-probability scenario."

Also, Roger Cole, the Fed's director of banking supervision, reassured lawmakers in testimony last week that he sees no spillover from subprime to standard mortgages.

"We expect a similar tone from Mr. Bernanke, which may impinge on the markets' view that Fed easing is only a couple of meetings away," writes Joseph Lavorgna, chief economist at Deutsche Bank.

Impinge away. It's all about managing expectations.