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Bernanke Gives the Buck His Blessing

Bernanke Gives the Buck His Blessing

Kathy Lien, Technical Strategist

Fed Chairman Bernanke’s comments about a potential unwinding of QE measures have given the US dollar rally new life, and the greenback is again soaring against the euro, yen, and commodity dollars.

Fed Chairman Ben Bernanke confirmed this morning that the central bank could reduce its pace of asset purchases "in the next few meetings." It took a while for Bernanke to make his point, and the US dollar (USD) endured a rollercoaster ride as a result, but the takeaway from his speech is clear: The Fed is serious about winding down quantitative easing (QE) and all of the speculation surrounding this possibility is now validated.

The US dollar has been on a tear since the beginning of the month and should extend its gains now that Bernanke green-lighted the rally. While the Australian dollar (AUD) and New Zealand dollar (NZD) have been hit the hardest by USD gains today, the biggest milestone was reached in USDJPY, which rose to a fresh 4.5-year high.

As long as there isn't a surprise contraction in the US economy in the late-second and early-third quarters, we believe the Federal Reserve plans to reduce monthly bond purchases in September. New York Fed President and Federal Open Market Committee (FOMC) voter William Dudley was a bit more specific than Bernanke this morning, saying it could be three to four months, which puts us right into the next meeting with a quarterly press conference from the Fed Chairman. This is a major change in policy, and Bernanke will want to manage the market's future expectations. The press conference gives him ample opportunity to do so.

Bernanke actually started his testimony sounding cautious, which caused the US dollar to tank. He said the job market was weak despite recent gains and warned that premature tightening risks slowing or ending the overall recovery.

On tapering, Bernanke said "we may or may not sell assets" and could "raise or lower purchases pace depending on data." However, almost immediately, he added that the Fed could reduce the pace of purchases in the next few meetings if economic data continues to improve, and this sent the dollar soaring.

While the Fed Chairman is worried about the high level of unemployment and the "substantial drag" that fiscal restraint puts on 2013 growth, inflation is low and the current level of interest rates is adding to employment, wealth, and the housing market. He spent a lot of time talking about an exit strategy, saying that winding down QE will be the first part of that plan and that allowing securities to roll off could be part of the strategy. His concerns about frothiness and bubbles also suggest the Fed is prepping for an exit even though the central bank will take baby steps towards it.

Now that the dollar rally has Bernanke's blessing, the greenback could extend its gains, especially if tomorrow's Eurozone PMI numbers surprise to the downside and European Central Bank (ECB) President Mario Draghi repeats that more Eurozone stimulus is likely.

The FOMC minutes will be released today as well, and while this still poses a risk to the dollar, the impact should limited because the Fed had stale data at that meeting.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.