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Dollar Reclaims Lost Ground on Persistent Uncertainty and More Flexible Bernanke

Dollar Reclaims Lost Ground on Persistent Uncertainty and More Flexible Bernanke

2010-03-26 00:47:00
John Kicklighter, Chief Currency Strategist
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Dollar Reclaims Lost Ground on Persistent Uncertainty and More Flexible Bernanke
It is natural for a sharp breakout-type move to follow up with a reasonable retracement. For the US dollar, this trader concept is further backed by fundamental reasoning. While the greenback would establish an impressive advance yesterday by breaking free of seven weeks of congestion; the move occurred despite relatively stable risk trends and in direct contrast to the prevailing build up in risk-laden positions evidenced in the Dow Jones Industrial Average’s climb to new highs on a near daily basis. Considering the benchmark currency’s primary role in the global financial market for more than a year-and-a-half now has been as a safe haven, this was a strong current to fight. And, just as we would expected, the morning hours would see a notable pullback from the dollar. What’s more, the general drift was further leveraged by the ‘progress’ the European Union summit would make towards agreeing on a clear and concise contingency plan for a Greek bailout. However, reflecting a deeper well of strength than a mere negative correlation to sentiment trends, the dollar would end up extending its bullish run for a third consecutive session through the end of Thursday. Of course, a well-timed, intraday reversal in the US indexes in the afternoon hours after the European markets had already closed certainly encouraged the greenback; the bigger picture shows a positive bearing from both currency and equity benchmarks since the former put in for a reversal in early December. Is this a transitory anomaly or a structural change? Only time can say for sure; but expect this relationship to be put to the test when sentiment finally establishes a clear and momentous trend.

While the dollar’s use as a safe haven has moderated under stable market conditions, the currency can make progress on the other side of the risk spectrum. Originally scheduled for February, but delayed by a snowstorm, Federal Reserve Chairman Ben Bernanke testified before the House Financial Services Committee Thursday. Having already released his prepared statement back on the initially set date, the market was well prepared with how the discussion would develop. However, the Q&A would not follow the same script. Making for splashy headlines, the central banker suggested there was still a need for “accommodative” policy for the immediate future. Other predictable remarks included suggestions that unemployment was “very week,” the housing sector is still struggling and policy would have to be tightened eventually. However, despite this boiler plate language, there were more than a few highlights. Somewhat subtle, but nonetheless remarkable was Bernanke’s suggestion that the term “extended period,” that has been the bane of Fed member Hoenig and interest rate hawks the world over, did not refer to a fixed time but rather depended on the evolution of the economy. This allowance of flexibility breaks up the hard fast position the Fed seemed to maintain (aside from some notable disagreement) and puts the group more on pace with the Bank of Canada. Another notable assessment was the suggestion that medium-term fiscal forecast was “somewhat dark.” Disappointment in fiscal policy is not unusual amongst central banks; but it is somewhat atypical for the US authority.

Related: Discuss the US Dollar in the DailyFX Forum, Dollar Forces an Essential Breakout but Where is the Drive?

Euro Excitement over Possible Accord for Greek Rescue Plan Limited
It has already been an active week on the topic of Greece and the European Union’s efforts to reach an agreement on how best to handle a potential rescue. In fact, officials have been so effective at voicing their opinions and standing that the first day of the European Union’s summit seems to come out to little surprise. After France decided to throw in with Germany and support a combination of Euro-area bilateral loans and IMF solution, it was all but a sure thing that that any definitive plan that met approval would come with under these specific guidelines (considering these are two largest EU members and the source to much of the area’s wealth). Though it may not be altogether official, this seems the outcome that will ultimately be adopted. For Greece, the deadline seems to have worked; and the solution is one that will support the economy. However, there is a reason that ECB Trichet said any IMF involvement would be “very, very bad” and others have suggested it could actually hurt the euro. Though it is not altogether certain that Greece will actually need assistance, this move suggests to the market that the EU is not altogether self-sustaining and is therefore less appealing as an alternative reserve to the US dollar. Far more important is the fact that this plan applies to Greece only. After Portugal’s downgrade yesterday, it should be apparent that this is a bigger problem than just one country.

British Pound Can’t Sustain Advance on Strong Sales Data, Fiscal Prudence
It is difficult to fight a well-entrenched trend. This is a trading maxim; but it also applies to sentiment and economics as well. The British pound should have found significant support in scheduled data and encouraging worlds from Chancellor of the Exchequer Alistair Darling; but the outlook for the currency proved too discouraging for the market to maintain its confidence for long. On the docket, was the typically volatile retail sales report. Following a January reading that was depressed by winter storms, February receipts jumped 2.1 percent for the biggest advance since May of 2008. And, following up on his budget report, Darling attempted to assure the market that there would be no emergency budget if the Labour Party was reelected – keeping with his previously established balance between economic support and fiscal prudence.

Japanese Yen Weighed by BoJ Member’s Endorsement of “Extremely” Lax Monetary Policy
In the financial markets, there are few certainties. However, it seems the notion that the Japanese yen is the ideal funding currency for the carry trade is one of those truths. In Thursday’s Asian session, BoJ member Kamezaki kept open the door for further financial accommodation when he suggested the bank should take action proactively and in remarking that the extremely accommodative policy was unshakable. However, there may be some reprieve in the deflation fight. The national inflation rate improved for a fourth month to a 1.1 percent pace of contraction.

Australian Dollar and Rate Forecasts not Bolstered by Optimistic RBA Forecast
Any concern that the RBA would turn a cautious after its (relatively) aggressive effort to tighten its monetary policy belt was dispelled by the semi-annual Financial Stability Review. In the report, the policy authority set its campaign to ensure inflation remained “contained.” With the economic outlook “considerably brighter” and housing seen creating pressure the 50 percent chance hike at the next meeting may be too dovish.

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Written by: John Kicklighter, Currency Strategist for DailyFX.com
E-mail: jkicklighter@dailyfx.com

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