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Potential Reaction to Bernanke

Over the next 48 hours, investors around the world will be transfixed on Bernanke’s semi-annual testimony on the economy and monetary policy.  Investors won’t have to wait long to get a sense of the Fed Chairman’s tone because the House Financial Services Committee will be releasing the prepared portion of Bernanke’s testimony 90 minutes before it is delivered live on Capitol Hill at 8:30am ET / 12:30 GMT.   Going into Bernanke’s speech, we expected the dollar to weaken but the question now is how the speech itself could affect the greenback.  While we don’t expect Bernanke to say anything dramatically different from last week, speeches by policymakers are organic and under tough grilling from Congress, Bernanke could reveal more than he otherwise wanted.

In our opinion, the highest probability scenario is continued dovishness from Bernanke.  We need to understand the audience that Bernanke will be speaking to tomorrow – members of Congress, most of whom will be screaming at him about the lack of stronger growth.  While the U.S. economy is in recovery mode, the pace has slowed and everyone from politicians to the average American would like to see a pickup in momentum.  Considering that the Fed is talking about tapering asset purchases, Bernanke will need to reassure policymakers that reducing asset purchases will not send the U.S. economy into a downward spiral and to do he will stress that monetary policy remains extremely accommodative and rate hikes are a long ways away.  Dovish comments should compound near term losses in the greenback but in the long run, we still feel that the dollar is headed higher.

The best outcome for the dollar would be if Bernanke focused on his reasons for why the economy is ready for a reduction in stimulus.  If the Fed Chairman spends the majority of his time on Capital Hill talking about the improvements in the economy, its promising outlook and dangers of leaving monetary policy easy for too long, the dollar could soar because these hawkish comments is a strong sign that the central bank will taper in September.

Either way, once the dust settles tomorrow, it is important to look beyond the immediate reaction to the overall course of the Federal Reserve.  Investors should ask themselves if Bernanke’s comments affect their plans to reduce asset purchases this year. If the answer is no, then a sell-off in the dollar could be viewed as a buying opportunity.  If the answer is yes then we can expect unwinding of some of the long positions built up in recent months, which means a stronger sell-off for the dollar.

GBP – Watch How BoE Carney Votes

Wednesday is a big day for the British pound. The Bank of England will be releasing the minutes from the very first meeting led by Central Bank Governor Mark Carney.    As the new Bank of England Governor, Carney has made transparency a priority for the central bank.  The minutes will give us a better sense of his overall degree of dovishness. Carney’s decision to release a more detailed monetary policy statement after the last meeting raised skepticism about the strength of the U.K. recovery that was later validated by weaker industrial production and trade figures.  In particular, we will be watching the tally of votes.  Former BoE Governor voted in favor of more asset purchases at his final meeting and if Carney takes over King’s spot voting in favor of more stimulus, we could see a renewed sell-off in sterling as this would serve as a reminder of the BoE’s dovishness.  If he votes for steady policy however, sterling could soar as this would leave the Monetary Policy Committee as a whole less dovish.  In addition to the BoE minutes, U.K. labor market numbers are also scheduled for release.  Jobless claims are expected to drop by about the same amount on the back stronger service sector job growth. U.K. inflation numbers were released this morning and as we suspected, CPI declined in June on summer discounting. Consumer prices fell 0.2%, but on an annualized basis, CPI growth accelerated to 2.9% from 2.7%.  The impact on sterling was short-lived as investors realized that the CPI report would not have a dramatic impact on BoE policy in the near term.

CAD – What to Expect from the Bank of Canada

The Canadian, Australian and New Zealand dollars traded sharply higher against the greenback.  While the AUD was the day’s best performer our focus tomorrow shifts to Canada where the Bank of Canada is scheduled to deliver a monetary policy decision.  The BoC is not expected to change interest rates but as usual, the bias of the central bank can affect how the currency trades.  This will be the first meeting led by Stephen Poloz and he is expected to repeat the BoC’s view that “the considerable monetary stimulus currently in place will likely remain appropriate for a period of time, after which some modest withdrawal will likely be required, consistent with the 2 per cent inflation target.”  Any deviation from the script could cause undue volatility in the loonie.  Since the last monetary policy meeting, we have seen more deterioration than improvement in Canada’s economy.  Manufacturing activity slowed significantly in the month of June, labor market growth stagnated (albeit after a very strong month), GDP growth slowed and retail sales less autos dropped for the second month in a row.  So if there is a shift in bias, it would most likely be towards more caution than optimism.  Meanwhile the Australian dollar soared on the back of the RBA minutes.  While policymakers were still concerned about the downside risks facing the economy, they felt that the inflation outlook was less benign and when combined with their view that the current level of monetary policy is appropriate” a short squeeze drove the AUD/USD sharply higher. With speculative AUD/USD short positions near record highs according to the CFTC IMM’s latest report, we would not be surprised if the AUD/USD rally extended for a few more days, especially if the Bernanke’s speech ends up driving the USD lower.  New Zealand consumer prices rose less than anticipated in Q2 but the downside surprise was quickly ignored in favor of the broad based commodity currency rally.

EUR – Unfazed by Weaker ZEW

The euro strengthened against the US dollar today despite weaker economic data.  The German ZEW survey of investor confidence unexpectedly declined to 36.3 from 38.5 in the month of July, adding to worries that the Eurozone’s largest economy is struggling to expand. While this was the first decline in three months, the increase in the current conditions of the report limited the impact on the EUR.  Also, the Eurozone ZEW survey rose from 30.6 to 32.8, reflecting optimism about the region as a whole.  Other reports were released including Eurozone CPI, which rose 0.1% and the Eurozone trade balance, which increased more than anticipated to 15.2B from 14.1B.  Unfortunately none of these reports are game changers for the ECB or the euro.  The ZEW survey is a measure of confidence whereas the IFO and PMI reports are measures of economic activity and the latter still gives the central bank reason for concern.  Instead, the single currency trickled higher on the back of U.S. dollar weakness and we expect this dynamic to continue over the next 24 hours as the EUR/USD takes its cue from the market’s reaction to Bernanke’s testimony.

JPY – What to Expect from BoJ Minutes

With no major Japanese economic reports on the calendar this week, there has been very little consistency in the performance of the Yen.  Japan’s currency strengthened against the euro, British pound, U.S. and Canadian dollars but weakened against the commodity currencies.  The only piece of Japanese data released overnight was Tokyo Condominium sales, which rose 22.0% year over year in the month of June, down from 49.2% yoy in May.  Condominium sales can be extremely volatile and not the best indication of Japanese economic activity. While machine tool orders are scheduled for release this evening, this final report should not have a significant impact on the Yen.  Instead, all eyes will be on the minutes from the June 10-11 monetary policy meeting.  If you recall, the BoJ left monetary policy unchanged in the midst of heightened volatility in the JGB market. By denying Japan additional stimulus at the time, the Bank of Japan sent a strong message to the market that central banks won’t be held hostage by market volatility and investors should not expect the spigots to be opened every time rallies are reversed. Most likely this will involve some degree of optimism from the BoJ.

Filed in: Commodities

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