Will Dr. Bernanke Provide a Clear Road Map at Jackson Hole?

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Daily FX Market Roundup 08-30-12

Will Dr. Bernanke Provide a Clear Road Map at Jackson Hole?
Euro Hit From All Sides
GBP: Will be a Tough Year for U.K.
AUD: Finance Minister Bemoans AUD Strength
NZD: All Commodity Currencies Extend Losses
CAD: GDP on Friday
JPY: Consumer Spending Weakens

Will Dr. Bernanke Provide a Clear Road Map at Jackson Hole?

With less than 24 hours to go before Bernanke takes to podium in Jackson Hole, Wyoming at 10am ET on Friday, the U.S. dollar traded sharply higher against most major currencies. The Japanese Yen was the only currency that outperformed the greenback, which unfortunately is a reflection of risk aversion. The price action in the currency and equity markets suggests that investors are giving Bernanke a taste of what to expect if he fails to provide any hints tomorrow on what the Fed could do in September. Investors are also starting to realize that their expectations may be high because there’s a very realistic chance for disappointment on Friday.

What the market wants is a clear road map for Fed policy. They want to be told definitively that the central bank will or will not ease next month. Unfortunately being straightforward has never been one of the Fed Chairman’s strongest personality traits and hoping for a clear road map tomorrow may be wishful thinking. Yet the one situation where Bernanke could still drop hints about easier monetary policy is if they already agreed to ease monetary policy through something other than Quantitative Easing. One possible option would be to extend their low rates pledge beyond 2014 or to tie interest rates with economic data. Both of these options would mark an important shift in U.S. monetary policy and is less drastic than a third round of Quantitative Easing and cheaper than asset purchases.

However there are plenty of reasons why Bernanke could choose to remain elusive about monetary policy. While the world was surprised by how close the Fed was to increasing stimulus in early August, the economy has improved since then. According to the Beige Book, there are signs of life in parts of the U.S. economy and continued challenges in others. The lack of consistency in the U.S. economy is the very reason why Bernanke could choose to wait until the latest official Fed forecasts are completed and the next non-farm payrolls report is released before committing to any fresh policy changes. Also, having provided signals to major policy changes at the last 2 Jackson Hole Summits, Bernanke may want to move away from the expectation that Jackson Hole is a forum for announcing policy changes. The topic for this year’s conference is “Achieving Maximum Long Run Growth” which implies that immediate firefighting policy changes are not on the top of the agenda. According to the CFTC’s IMM data on speculative positioning, dollar positions are fairly neutral right now which means investors are not positioned one way or the other. If Bernanke sticks to script and simply reiterates the central bank’s pledge to do what is necessary for the U.S. economy leaving investors guessing for a few more weeks before the Fed meeting, the dollar could rise. If he sounds pessimistic and focuses on the problems in the U.S. economy, expectations for significant action in September could return, driving the U.S. dollar lower.

Euro Hit From All Sides

Demand for U.S. dollars, weaker Eurozone economic data, comments from European leaders and the IMF along with higher Spanish bond yields pressured the EUR/USD lower throughout the North American trading session. The day started off with comments from German Chancellor Merkel who said unlimited bond purchases would violate the ECB’s mandate and small volume purchases would have limited impact. This suggests that she won’t stand in the way of the ECB’s current plan for short term bond purchases, which we expect to hear a lot more of next month. French President Hollande on the other hand said he expects sustainable decisions to be made at the October EU Summit and if true, then the next 2 months could be particularly interesting for the EUR/USD. Despite the recent decline in bond yields, the leaders of both France and Spain believe that borrowing costs are too high and according to Hollande, ECB intervention is justified if spreads are at excessive levels. The French President also alluded to Spain’s inevitable need for a broader bailout when he said if Spain wants to wait for more details before making a formal request, its understandable. The IMF warned that implementing austerity measures could be a serious challenge for Greece and said there’s room for the ECB to increase policy accommodation if needed. Meanwhile German unemployment was revised higher in July from 7k to 9k and increased by the same amount in August. According to our colleague Boris Schlossberg, Chinese Premier Wen Jiabao also stated that he was more confident about the euro area after meeting today with Merkel and promised to continue to buy EU government bonds after fully assessing risks. China’s vote of confidence for the euro is important, but the rise in Spanish and Italian bond yields and dive in the EUR/USD suggests that stronger auctions have not done much to reduce the risk premia in the market. While the market’s focus will be on Bernanke’s speech tomorrow, German retail sales are also on the calendar.

GBP: Will be a Tough Year for U.K.

The British Pound sold off aggressively against the U.S. dollar today after rising to a high of 1.5875. According to the Confederation of British Industry, Britain’s economy will shrink this year for the first time since 2009. GDP will fall 0.3% this year and rise 1.2% in 2013. It was adjusted from the previous forecast of 0.6% and 2% increase, respectively. UK mortgage approvals rose in July by 47.3K, down from 44.1K the prior month. Net lending securities on dwellings on the other hand rebounded to 1.1B from -0.2B. CBI Director General John Cridland said, “The economy is flat rather than falling but, nonetheless, momentum seems to have weakened. Underlying growth will return to the economy later in the year than previously expected, with a somewhat better outlook next year. The risks are very much on the downside.” Hometrack released a report on August 27 that said house prices fell 0.1% this month. House prices are tightening as banks restrict lending and UK’s economy is struggling to recover from a recession. The Bank of England is currently in the process of purchasing 50 billion pounds of bonds, which is due to end in November. Bank of England said today that the M4 money supply increased 0.5% in July. GfK consumer confidence and nationwide house prices are scheduled for release tomorrow.

AUD: Finance Minister Bemoans AUD Strength

The Australian, New Zealand and Canadian dollars extended their losses against the greenback. The Aussie has been sold aggressively for most of the month and was dragged down further by comments from the Finance Minister. Ms. Wong said that the high level of Australian dollar poses challenges for Australian companies and if the Reserve Bank chooses, they have room to move. While she is stating the obvious, her concerns about AUD strength added salt to the wound. Australian building approvals dropped 17% in July when it was only expected to decrease by 5%. Australia’s private capital expenditure expanded more than expected in the second quarter by 3.4%. Australia faces two critical problems, which is their slowdown in commodities exports and strong currency. The Reserve Bank of Australia lowered rates by 75 basis points in May and June to protect against the exposure of the Eurozone crisis and slower growth from China. RBA Governor Glenn Stevens says the rate reduction have resulted in borrowing costs “a little below their medium-term averages.” The RBA has left the bank rate unchanged for the past two meetings and said last week that policy makers are equipped to handle the situation should the economy slow down. Perhaps more rate cuts are on the way. New Zealand business confidence index rose to 19.5. Building consents are also up 2%. In the housing report, industry and labor statistic manager Blair Cardno said, “Apartments boosted the increase in new housing consented in July.” Australian private sector credit and Canadian GDP are due for release tomorrow.

JPY: Consumer Spending Weakens

The sell off in stocks and overall sense of risk aversion drove the Japanese Yen higher against all major of the currencies today. Retail sales declined more than expected in July by 1.5% in the world’s third largest economy. Economists expected a decline of 0.5% and said bad weather played a role in poor sales. Sales by large retailers declined 4.4% against an expected decline of 3.2%. According to the Japan Business Federation (Nippon Keidanren), small summer bonuses paychecks may have also contributed to the worst than expected sales. Large companies offered fewer pay compared to previous years. The Cabinet Office downgraded its assessment of its economy for the first time in 10 months on August 28 after shipments with the European Union declined 25% in July from a year earlier. In other news, Yoshihiko Noda may be at risk of losing his job after enraging anti-nuclear activists for restarting nuclear reactors, raising taxes and splitting up his party. He split the Democratic Party of Japan in passing his proposal to double the sales tax and now Noda must convince the DPJ to keep him as its head in a party leadership contest coming up. It’s a busy night in Japan with the jobless rate, industrial production, CPI, and household spending data due for release.

Kathy Lien
Managing Director

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