What a Week: Ben's Bulls

Stocks get a kick out of Bernanke's upbeat economic assessment.
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Wall Street welcomed Ben Bernanke with open arms this week.

In his first testimony to Congress, the new

Federal Reserve

chief was bullish about the economy, predictably so given evidence of a rebound in growth in the first quarter. Since his language sounded bullish for profits, Wall Street was able to digest Bernanke's reiteration that more interest rate hikes are probably in the offing.

A similar dynamic was evident on Friday, when the market was able to handle news that producer prices, ex-energy, had increased more than expected in January. After early weakness, also caused by disappointing guidance from

Dell

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, stocks finished with only modest loses on the day: 5 points on the

Dow

; 2 points on the

S&P 500

and 12 points on the

Nasdaq

.

For the week, the Dow gained 196 points, or 1.79%. The S&P 500 finished up 20 points, or 1.57%, and the Nasdaq added 20 points, or 0.88%.

Wall Street was also reassured that Bernanke planned continuity with Alan Greenspan, his predecessor, by presenting himself first and foremost as an inflation fighter. He had been, rightly or wrongly, seen as a dove on inflation for suggesting during the 2003 deflation scare that a central bank could always dump money from helicopters to jump-start the economy.

Long-term bonds prices were higher at the end of the week, sending their yields -- which move inversely -- lower. Yields rose through January and early February as an unusual amount of governmental debt hit the market and economic data came in hot, lifting inflationary pressures. They reversed as investors became more comfortable with the Fed's anti-inflation resolve.

And although filling in Greenspan's shoes is no easy task, Wall Street apparently liked the bravado with which Bernanke fielded questions from congressmen on both sides of the aisle.

"A fair portion

of this week's rally had to do with this cloud of uncertainty lifting over the Fed," says Jack Ablin, chief investment officer at Harris Bank.

Bernanke's hawkish tone convinced more people that the Fed would hike rates at least two more times, on March 28 and on May 10, bringing its key overnight rate to 5%. That, in turn, helped keep commodities, such as gold and energy, under pressure -- another anti-inflation catalyst, according to Ablin. Commodities have suffered a mini-meltdown over the past two weeks.

Crude oil fell back below $60 per barrel this week. It rose 2.3% to $59.80 per barrel Friday after a minister from the Organization of Petroleum Exporting Countries suggested the cartel should cut production next month.

Gold also gained Friday, rising $1 to $554.70 per ounce, finding support from the inflationary implications of rising producer prices.

Some Fed watchers were also happy with Bernanke's plain-spoken style. "For the first time in 18 years, we managed to get through one of these semiannual congressional testimonies without a bottle of Advil in one hand and a thesaurus in the other," wrote David Rosenberg, chief economist at Merrill Lynch.

Yet, all in all, Bernanke added nothing new to the sum of knowledge about the economy or about the direction of interest rates.

He acknowledged what everyone already knows -- that a slowing housing market, which has been the linchpin of consumption via ever-rising home equities over the past few years -- creates risks for the economy. Yet, he believes that the market need not collapse, as mortgage rates remain relatively low. What else was he going to say?

Similarly, the soaring current account deficit remains well-financed by willing lenders from around the globe, Bernanke said. This keeps long-term bond and mortgage rates low, in turn allowing indebted U.S. consumers to continue their spending binge.

Wall Street, however, didn't seem to pay too much attention to something else going on during the testimony, which might in fact contradict Bernanke's reassuring scenario: The level of virulence expressed by Congress toward China, which after a tiny revaluation of its currency -- the yuan -- last year, has kept it pegged to the dollar at an artificially low level. This keeps Chinese exports extra competitive vs. the U.S. and other exporters.

Just as congress members peppered Bernanke with questions about China, Treasury Secretary John Snow also said he was "not satisfied with yuan reform." According to Jay Bryson, global economist at Wachovia, Treasury officials have been "making the rounds to inquire what the market reaction would be" if they were to brand China a "currency manipulator."

In a year when Congress is facing mid-term elections, the rhetoric could intensify, according to Don Straszheim, president of Straszheim Global Advisors, and a specialist on China.

Criticism of

Google

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, which has allowed China to censor its content, was just one of several instances of mounting congressional pressure on China.

"I think something's going on here," Straszheim says. "Washington is increasingly of the mind that China needs to accelerate the process of modernizing its economy and harmonizing its economic rules with the rest of the world."

Straszheim expects that China, although it won't be bullied around, will make another move toward revaluation sometimes around April, when Chinese president Hu Jintao is scheduled to come to the U.S.

The downside: This could put some pressure on U.S. long-bond rates, and therefore on mortgage rates as well. China owns about $250 billion worth of Treasury bonds, or roughly 5% of marketable Treasury debt outstanding, according to Bryson. It has continued to accumulate Treasuries as a way of recycling all the dollars it buys to keep the yuan weak. "If indeed the Chinese government allows the currency to strengthen at a faster pace, it would not need to buy as many dollars in the foreign exchange market," Bryson wrote.

Should the move scare enough owners of Treasuries, a spike in long-bond and mortgage rates is possible, accelerating the slowdown in the housing market. This remains a doomsday scenario. But it might be good for Wall Street to remember that Bernanke's role in this would be limited to dealing with the aftermath.

In keeping with TSC's editorial policy, Godt doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He appreciates your feedback;

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