US Dollar Seen Higher as Bernanke Disappoints, Euro Crisis Festers

Major Currencies vs. US Dollar (% change)

20 Aug 2012 – 24 Aug 2012

Talking Points

• All Eyes on Fed Chair Bernanke’s Jackson Hole Speech Amid Stimulus Hopes
• US Manufacturing Surveys, Beige Book to Set the Tone for QE3 Expectations
• Euro May Suffer on EU Policymakers’ Dithering as Markets Grow Frustrated

Although correlations have broadly weakened in the late-summer trading lull, sentiment trends continue to look like the leading driver for most major currency pairs. USDJPY is a lone exception, although a strong relationship with the 10-year Treasury bond yield still anchors the pair to risk appetite given the safe-haven status of US debt. This puts familiar big-picture themes – the global economic slowdown and the Eurozone debt crisis – at the forefront once again.

On the growth side of the equation, all eyes will be on Friday’s Jackson Hole symposium and a speech from Fed Chairman Ben Bernanke. The central bank chief used the venue to signal QE2 in 2010 and traders are speculating that the third round of asset purchases may emerge this time around. Last week, a dovish set of minutes from Augusts’ FOMC sit-down fueled bets on imminent accommodation, but dismissive comments from St. Louis Fed President James Bullard quickly poured water to the doves’ exuberance. Bullard said the minutes were dated in light of the improvement in US economic data through July and August, hinting the Fed may not see the landscape as warranting a reboot of asset purchases. US economic data has notably improved relative to expectations recently, reinforcing Bullard’s position.

Faced with these conflicting cues, traders will closely monitor next week’s stock of manufacturing survey data from the Richmond, Kansas City and Chicago Fed branches to set the stage for Bernanke’s speech. The Beige Book survey of regional economic conditions and Augusts’ Consumer Confidence reading will likewise meet with close scrutiny from investors. On balance, an unequivocal nod toward QE3 seems unlikely. Medium-term inflation expectations remain reasonably anchored near the Fed’s target 2 percent rate and borrowing is materially cheaper than it was when QE2 emerged, with Treasury bond yields sitting near record lows. That means the Fed is likely to reserve QE3 as an available tool in its arsenal in the event that the mess in Europe triggers another credit crunch akin to the aftermath of the bankruptcy of Lehman Brothers in 2008.

Turning to the Eurozone, last week’s anticlimactic developments in Greece and further stalling from the ECB on its bond-market support program revealed investors’ frustration with a lack of directional cues – whether positive or negative – from Eurozone officials. Markets may be approaching a juncture where price action forces policy once again, with risk aversion breaking out amid signs of continued dithering. The focus is now on a formal review of Portugal’s EU/IMF bailout program and a set of bond auctions from Spain and Italy (where average yields and bid-to-cover readings will be closely monitored as a gauge of funding stress). With little in terms of a breakthrough likely on the horizon, a round of risk aversion may be brewing to punish policymakers’ foot-dragging.

EURO

Source: Bloomberg

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BRITISH POUND

Source: Bloomberg

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JAPANESE YEN

Source: Bloomberg

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CANADIAN DOLLAR

Source: Bloomberg

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AUSTRALIAN DOLLAR

Source: Bloomberg

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NEW ZEALAND DOLLAR

Source: Bloomberg

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--- Written by Ilya Spivak, Currency Strategist for Dailyfx.com

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