Thank Bernanke for Dollar Rally

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Fed Chairman Ben Bernanke’s prepared testimony on the economy and monetary policy provided no new indication that the Federal Reserve is any closer to pulling the trigger on QE3. This sent the U.S. dollar soaring against all the major currencies because it means that while September is still in play, raising asset purchases in August is completely off the table. Bernanke expressed his frustration on the slow progress of joblessness and his disappointment in U.S. data, but none of this mattered because he never hid his pessimism from the market. What investors wanted to hear were clear signals on the timing for QE3 and unfortunately Bernanke failed to deliver. He reiterated that the Fed is prepared to ease further if necessary but declined to mention specific steps which means the door is open but they are still not ready to walk through it.

Bernanke’s noncommittal comments on QE3 is consistent with the central bank’s strategy of continuing to bide their time until there is unambiguous evidence that another round of asset purchases is absolutely necessary. Two more months of job growth less than 100k and another month of negative retail sales could do the trick. With approximately 8 weeks between now and the September 13th monetary policy meeting, a lot could happen in the financial markets and in the U.S. economy. If Bernanke wanted, he could still signal plans for QE3 at the annual Jackson Hole Economic Summit of central bankers in late August. Both the 2010 and 2011 Jackson Hole Summits were Bernanke’s venue of choice for signaling a major change in monetary policy – in 2010, Bernanke delivered his infamous speech that tipped off the market that QE2 was on the way and in 2011, he expanded the FOMC meeting from 1 to 2 days to outline the details for Operation Twist.

With very little consensus within the central bank, increasing asset purchases in 2 months instead of 2.5 weeks is far more realistic. By then, the latest FOMC forecasts would have been released, giving central bank officials a much better sense of how the economy is faring. Furthermore, the timing of the September FOMC meeting is perfect because Bernanke could use the Jackson Hole Summit to signal a potential change, make the change in September and then answer questions at the regularly scheduled post monetary policy meeting press conference.

Yet even though September is still in play, the monetary policy meeting is not for another 2 months, which means in the near term expectations for less aggressive balance sheet expansion should keep the dollar bid and send the EUR/USD on its way to 1.20.

Bank of Canada is Still Talking About Raising Interest Rates

Earlier this morning, the Bank of Canada left interest rates unchanged at 1.00%. The monetary policy statement was significantly more cautious than last month’s with the central bank lowering their 2012 and 2013 GDP forecasts. Slower than anticipated growth in the U.S., China and other emerging markets along with a renewed contraction in Europe put pressure on the price of oil – the lifeblood of Canada. Although the July BoC statement was significantly less optimistic and more dovish than the June statement, the Canadian dollar soared because even with all of the clear signs of slower growth abroad, the central bank still held onto their view that “some modest withdrawal of the present considerable monetary policy stimulus may become appropriate.” In other words, the Bank of Canada is still talking about raising interest rates which is a surprise considering that domestic and international economic conditions have deteriorated over the past month. This moderately hawkish monetary policy stance sets the Bank of Canada apart and should lend support to the loonie.

Kathy Lien
Managing Director

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