Bernanke and the Dollar Rally Take the Stand
Currencies and equities were trading higher ahead of Federal Reserve Chairman Ben Bernanke's Wednesday testimony before the Joint Economic Committee. While the Federal Open Market Committee (FOMC) meeting minutes will be released on the same day, we believe Bernanke’s monetary policy bias will be the main driver of US dollar (USD) flows.
Bernanke's views will give us a good sense of whether the market's expectations for tapering quantitative easing (QE) are overblown. Based on the relentless rally in the US dollar over the past month, investors are pricing in a major change in Fed policy, and Bernanke's comments could either support or end the dollar rally.
Based on the latest comments from FOMC voters William Dudley (New York) and James Bullard (St. Louis), there's no clear support for tapering asset purchases. Dudley and Bullard are on two opposite sides of the dove/hawk scale, and yet Dudley says that he's not sure if the next move in QE will be up or down, while Bullard says he doesn't see a good case for tapering asset purchases unless inflation rises.
The ball is now in Bernanke's court, and if the Fed Chairman drops even the smallest hint that he supports reducing bond buying—either by talking about it directly or sounding more optimistic about the outlook for the US economy—the dollar could hit new highswith USDJPY likely reaching the 104.00 handle.
As one of the more dovish members of the FOMC, Bernanke will be careful with his choice of words. We don't expect the Fed chief to openly say that the economy has improved enough to warrant changes in monetary policy, and while we don't expect Bernanke to kill the dollar's rally intentionally, his caution could lead to profit taking.
In the long run, we expect more gains in the greenback relative to other currencies, but the FOMC minutes and Bernanke's testimony pose a double threat to the dollar rally on Wednesday. Aside from those event risks, existing home sales are also scheduled for release.
British Pound (GBP) Gets a Scare
Tuesday’s worst-performing currency against the euro (EUR) and US dollar was the British pound (GBP), which tanked after softer inflation reports. Both consumer and producer prices surprised to the downside with PPI input and output declining in the month of April and consumer price growth slowing to 0.2% from 0.3%. This cut the year-over-year rise to 2.4%, which is the lowest level of inflation since October 2012. The equally large decline in core prices confirmed that the decline in inflation is genuine, and for the Bank of England (BoE), this puts additional easing back on the table because it seems that CPI may undershoot the BoE's expectations.
However, the real key to additional stimulus lies in the performance of the economy, which got a scare from Wednesday’s horrid UK retail sales report, which printed at -1.3% versus 0.0% forecast. This was the worst reading since April 2012 and was driven by a sharp drop in food store sales and weak sales of summer items due to bad weather conditions. Some of the decline may have been seasonal, but the overall number suggests UK consumer demand remains weak, and despite the recent spate of better-than-expected economic numbers, the UK economy remains vulnerable to further contraction.
In addition, the BoE monetary policy committee (MPC) meeting minutes revealed a surprisingly dovish stance, with three of of the nine members continuing to vote for more QE. With UK pricing pressures clearly receding, the prospect for more QE has increased, especially if the economic data begins to wobble again. The GBPUSD reacted negatively to the news, dropping below the 1.5100 level. The pair may test the 1.5000 figure later today if the dollar catches a bid.
EUR/USD on Breakout Watch
For the fifth consecutive trading day, the EURUSD remained stuck in a range, trading between 1.28 and 1.2950. The lack of market-moving Eurozone data early this week restricted movements in the shared currency.
Lower price pressures will most likely keep the European Central Bank (ECB) dovish, but the key to additional easing is not inflation, but economic performance. Eurozone current account numbers are due for release on Wednesday, and with German and French balances increasing in March, the Eurozone figures should show improvement as well.
EU Leaders will be holding a summit in Brussels on Wednesday as well, so watch for headlines related to the economy. While the EUR/USD has consolidated above 1.28, key Fed events could drive it out of this range with volatility continuing into Thursday and Friday on the back of Eurozone PMI numbers, a speech from ECB President Mario Draghi, and the German IFO report.
In other words, don't get too comfortable with the recent range-bound trading in the euro, as a breakout could be right around the corner.
The Main Takeaway from the RBA Minutes
After a one-day respite, the New Zealand dollar (NZD) and Canadian dollar (CAD) resumed their slide against the greenback while the Australian dollar (AUD) steadied. A decline in Australian leading indicators and benign Reserve Bank of Australia (RBA) minutes prevented the AUD from enjoying a stronger recovery.
The minutes did not provide much in the way of guidance on future monetary policy, but the central bank's careful choice of words suggests that there is room for more stimulus. The RBA statement indicated the "inflation outlook would afford scope to ease further" and they decided to use "some of that scope" to ease still.
The main takeaway from the RBA minutes is that the strength of the Australian dollar in April was the primary motivation for their decision to cut interest rates. Aside from constricting export activity, the rise in the currency also reduces inflationary pressures, giving the central bank the flexibility they need to ease monetary policy.
Since then, the AUDUSD has fallen aggressively, losing approximately 800 pips from its April high and making the currency far less of a concern these days. Therefore, another rate cut by the RBA would probably require material deterioration in economic data.
Meanwhile, the NZDUSD shrugged off stronger credit card spending numbers.
By Kathy Lien and Boris Schlossberg of BK Asset Management
DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.