Daily FX Market Roundup 07-17-12

Why US Dollar Reversed After Bernanke Testimony
EUR: Don’t Lose Sight of Lingering Risks
GBP: All Eyes on the Pound
CAD: BoC Keeps Higher Rate Bias
AUD: RBA Content with Interest Rates
NZD: Slower Consumer Price Growth
JPY: IMF Lifts Japan Growth Forecasts

Why US Dollar Reversed After Bernanke Testimony

Fed Chairman Ben Bernanke’s testimony before the Senate triggered widespread volatility in currencies. When Bernanke first spoke, the U.S. dollar soared against all the major currencies because Quantitative Easing was not mentioned as a possible tool to stimulate the economy. Based on his prepared remarks, Bernanke is clearly frustrated with the pace of recovery but he deliberately stopped short of mentioning more QE because he knew that doing so would spark speculation of action in August, a decision that they were not prepared to make. However as the question and answer session began, it quickly became clear that Bernanke would not be able to avoid discussing his plans for monetary policy and more specifically Quantitative Easing. About 20 minutes into the Q&A session, Bernanke admitted that they have a range of possibilities for more easing including more QE, using the discount window and cutting the interest rate on excess reserves. Their challenge right now is figuring out whether the “loss of momentum in the economy is enduring.” However as the evidence shows, there is “frustratingly slow” progress on joblessness and a modest risk of deflation. This means that while August is out, QE3 is still an option for September. When the dust settled, investors realized that nothing Bernanke said today removed the risk of additional stimulus and for the currency market this means there is no justification for a dollar rally. If anything, Bernanke’s concerns about deflation should tell us that the central bank remains in easing mode. FOMC member Pianalto spoke after Bernanke testimony and she confirmed that the economy needs ”highly accommodative monetary policy.”

Bernanke’s noncommittal comments on QE3 are consistent with the central bank’s strategy of biding their time until there is unambiguous evidence that another round of asset purchases is 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. While Bernanke will be testifying again before the House, the statement will be the same, which means that the more important release tomorrow could be the Federal Reserve’s Beige Book report.

EUR: Don’t Lose Sight of Lingering Risks

The euro ended the North American session higher against the U.S. dollar. One of the most relevant questions that we were asked today was whether we are finally in an environment where U.S. data and QE3 matters. There is no question that QE3 or no QE3 is playing a big role in the day to day movements of currencies but while Europe’s crisis has faded to the background it has not disappeared Spain is scheduled to sign a memorandum of understanding for its bank bailout plan at the end of this week and with some details still unknown, there could be some euro induced volatility for currencies towards the end of this week. ECB President Draghi said this morning that the question of burden sharing with senior bondholders is being discussed on the European level. Even Bernanke said there is a possibility that the situation in Europe could worsen. Given the troubles in Spain, it is no surprise that German investor confidence hit a 6 month low in July. The ZEW survey of economic sentiment dropped to -19.6 this month from -16.9. The threat of continued fiscal problems, recessionary conditions across the region and weakening demand for German exports made investors more pessimistic about current and future economic conditions. As a result, there could be serious obstacles to a EUR/USD recovery.

GBP: All Eyes on the Pound

Despite evidence of weaker inflationary pressures, the British pound ended the day unchanged against the U.S. dollar and euro. Consumer prices dropped for the second month in a row as retailers cut prices to lure in customers. Annualized CPI growth has fallen to 2.4 percent, which is dramatic decline from its high of 5.2 percent less than a year ago. While inflation is still above the central bank’s 2 percent target, it is now comfortably below 3 percent, which means the BoE no longer needs to to write a letter of explanation to the Chancellor. Based on the trend of inflation alone, we can understand why the Bank of England increased asset purchases earlier this month. Tomorrow we will learn exactly how many members of the monetary policy committee voted for the increase – the greater the consensus, the greater conviction. In addition to the voting record, we will also be looking for any hints about future monetary policy. If the minutes reveal that the BoE has shifted to neutral, sterling could rally. Labor market numbers will also be released on Wednesday and based on KPMG who reported the sharpest job loss in 3 years, the odds favor greater job losses.

CAD: BoC Keeps Higher Rate Bias

The Canadian, Australian and New Zealand dollars ended the day higher against the greenback. Earlier this morning, the Bank of Canada left interest rates unchanged at 1.00%. Their 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. Meanwhile the Australian dollar was the day’s best performing currency thanks to the RBA minutes, which showed the central bank content with the current level of interest rates. As expected, consumer price growth in New Zealand slowed due to the global decline in commodity prices.

JPY: IMF Lifts Japan Growth Forecasts

The Japanese Yen weakened against all of the major currencies. After a three-day sell off in USD/JPY, Finance Minister Jun Azumi warned that the central bank would take action against the yen’s strength if needed. In regards to addition stimulus, Azumi said the government needs to consider compiling an extra budget while reviewing downside risks to the economy when the Cabinet releases their April-June GDP numbers in August. Most Asian stocks fell as US retail sales declined on Monday. However, Asian stocks rebounded after the IMF raised Japan’s GDP forecast to 2.4 percent this year up from their prior estimate of 2 percent growth back in April. Stronger domestic demand is helping the economy but next year growth is expected to slow to 1.5 percent. Tokyo condominium sales and machine tool orders are the only pieces of Japanese data on the calendar tomorrow.