Dollar flexes muscles before Bernanke pep-talk

IB FX Brief

Friday August 26, 2011

Earlier losses for the dollar were reversed in early New York trading ahead of Friday’s long-awaited pep-talk by Fed Chief Bernanke. However, very few analysts expect his words to set the world alight in Jackson Hole. Last year the announcement of the Fed’s preparedness to act if conditions worsen was taken as a clear sign that QE2 was coming. That hint snowballed in to a series of discussions among economists and even a survey from the New York Fed polling treasury dealers on what size they predicted, what impact it might have on yields. All we can really expect to walk away from the speech with is shorter odds of the likelihood of further easing.      

U.S. Dollar – Thursday’s jump in the dollar accelerated when selling picked up across German equities amid rumors that authorities might enact a short-selling ban and that the leading European nation was on the verge of a ratings downgrade. It appears that a large institutional investor was positioning (or exiting a sizeable short position) on the eve of the Bernanke speech. This morning those gains had earlier given way to the lingering fear that more easing remained a possibility, which most concur is a dollar negative. If Bernanke unveils an array of additional policy tools, which the FOMC alluded to in the August press statement, currency investors will quickly try to assess whether these would be a better alternative to asset purchases, which they claim increases the supply of dollars. Watch out for the Chairman to highlight that while growth has turned out slower than hoped, we’re still in a better place than a year ago. And by proving the inflationary implications of quantitative easing the risks to further easing are higher than before. But as a necessary evil, the Fed stands prepared by its bed to act should the situation worsen.     

Japanese yen – Prime Minister Naoto Kan finally agreed to step down as Japan’s leader after the final pieces of his legislation were passed. His 14-month rule was shattered after by a lack of crisis-management leadership. Finance Minister Noda is now likely to battle with other contenders next weekend to claim the top ministerial position. The Nikkei newspaper also said that the government would on Monday announce new measures to aid the economy counter a stronger yen. Weakness in global stocks ahead of Bernanke’s speech saw the yen surge to ¥76.56 on Friday.          

Euro – The euro reached $1.4452 but technically speaking continues to put in a series of lower highs on each rally. Friday’s optimism was earlier sparked by a Financial Times report that EU leaders were likely to sit down and discuss a new version of Finland’s recently agreed collateral agreement with Greece. Rather than cash, the agreement explores the possibility of real estate or equity stakes in state-owned assets claims the FT. Early optimism that the euro would remain in favor over the dollar post-Bernanke gave way to selling with the single currency easing to $1.4395.     
 
British pound – The pound is sitting on a two-week low against the dollar at $1.6268 as it is per euro at 88.52 pence after a weak GDP report. The economy grew by 0.2% in the second quarter and expanded at a 0.7% annual pace. The more important services sector grew by 0.5% while manufacturing output fell by as much. Overall industrial production, which adds utility and mining output, contracted by 1.6%. MPC outsider Martin Weale confessed that the shakier external environment was behind his decision this month to drop his call for a tightening of monetary policy. Asked by the Yorkshire Post newspaper whether a resumption of asset purchases might be warranted Mr. Weale said that although remote at this point, he might back such a call if banks’ aversion to lending should increase. Given the vice-like fiscal austerity measures aimed at delivering a balanced budget within half a decade the pound continues to look vulnerable to a weakening economy.

Aussie dollar – Investors dashed back in to the Aussie unit when they heard Reserve Bank Governor Glenn Stevens seemed to warn over inflation in testimony to parliament. The Governor said inflation “bears watching carefully but we can keep it under control.” The remarks vindicated the Aussie bulls looking beyond the global debt crises expecting growth to resume leaving the central bank on a tightening trajectory. It may be a long time before those storm clouds clear, however. The Aussie hit $1.0516 before it soured in New York to $1.0478 U.S. cents.        

Canadian dollar – Not to be outdone by a huge spike lower on Thursday the greenback exacted revenge on the Canadian dollar following a weaker than forecast GDP report. The Canadian unit slumped to a low at $1.0082 cents as investors picked holes in a 1% second quarter pace of annualized growth in the world’s number one economy.     

Andrew Wilkinson                                                                   
Senior Market Analyst                                                               ibanalyst@interactivebrokers.com