Wild Swings in US Dollar – Main Takeaway from Bernanke’s Speech

Talk about volatility! The biggest event of the week proved to be the biggest catalyst for volatility in FX market and the U.S. dollar specifically. When Ben Bernanke took to the podium today in Jackson Hole Wyoming, the U.S. dollar sold off aggressive as soon as the statement was released. However once everyone had a chance to look beyond the headlines and read through the full speech, they realized that the Fed is still leaning towards increasing stimulus, just maybe in October and not September. As a result, they returned to selling dollars and within 25 minutes of the release of Bernanke’s speech, the greenback gave up nearly all of its earlier gains. Today is also the end of the month and the rally in U.S. equities in August means that the dollar needs to be sold for month end fixings.

The Fed Chairman had some tough words to say about the state of the U.S. economy, the most important of which was his concern for the labor market. The uptick in job growth last month did not make the central bank feel any better – Bernanke said the stagnation in the labor market is “grave concern” and high unemployment could wreck structural damage on the economy. He believes that the economy still faces daunting challenges from a weak housing market, uncertainty in Europe and the U.S. fiscal cliff. While Bernanke started his speech by saying that he “wouldn’t rule out further asset purchases” and promised to “boost accommodation as needed for growth,” these words were not enough to satisfy short U.S. dollar traders looking for a stronger commitment to QE3 because he added that a “big boost in QE could reduce confidence in a smooth exit.”

Given his views on the labor market and the overall economy however, the main takeaway from Bernanke’s speech is that the recovery is a big disappointment and more action is to come. Bernanke certainly believes in the effectiveness of Quantitative Easing as he spent most of his speech justifying the effectiveness of past asset purchases.

Looking ahead the most important question for the U.S. dollar is whether the Federal Reserve will change monetary policy on September 13th. Unfortunately Bernanke did not lay out a clear road map for monetary policy and only implied that more stimulus will come eventually. Yet the Fed could still ease in September without resorting to the extreme measure of QE3. As a middle ground, the central bank could opt to extend their low rates pledge from 2014 to a later date and combine it with a statement that pledges to maintain a highly accommodative stance as the economy recovers. They could also tie this pledge to changes in the economy such as inflation or employment.

Either way, September 13th is a very important FOMC meeting that will require a lot of preparation by the central bank because fresh forecasts for the U.S. economy including GDP, inflation and unemployment will be released on that Thursday. Bernanke also has a press conference scheduled where he will have an opportunity to explain any policy actions or lack thereof and changes to the Fed’s view. In other words, it is a critical meeting and one with all the right ingredients for easier monetary policy.