After a savage squeeze on long positions, fundamentals are likely to push the dollar stronger again this week. Fed Chairman Bernanke's crucial testimony is likely to take a slightly more hawkish slant, especially as markets over-interpreted more dovish elements last week. The prospects for US outperformance, together with a lack of attractive dollar alternatives, are also likely to be highlighted by China's GDP data and wider vulnerability within emerging markets. Overall, with eurozone peripheral politics in disarray, there is scope for dollar gains against all major European currencies. Look to sell EUR/USD around 1.31 and GBP/USD above 1.5180 while buying USD/CHF around 0.94.
1. Highlight of the week will be Fed Chairman Bernanke's testimony to Congress as he appears before the House of Representatives Financial Services Committee on Wednesday and Senate Banking Committee on Thursday. The Fed chief will make a prepared statement followed by a Q&A session. The dollar was unhinged last week by a more dovish than expected speech from Bernanke with bond yields sharply lower. Markets had moved too far towards expecting a Fed tightening, which left the US currency vulnerable to a sharp squeeze on long positions.
Bernanke will be looking to maintain and communicate consistency in the underlying rhetoric. His key message is still that interest rates will remain extremely low even when bond buying comes to an end and that tapering will start this year unless there is a sharp deterioration in economic data releases. The problem for the Fed chief is that market sentiment lurched too far in one direction and has now swung too far the other way. If Bernanke maintains a broadly consistent overall message with expectations of tapering in September and shifts his rhetoric only marginally, there will be fresh dollar support but no rampant buying.
2. The latest Chinese GDP data will be released on Monday, together with data on retail sales and industrial production. The official consensus is for annual GDP growth to be marginally weaker than the first quarter's 7.7%. There is a high risk that reported growth will be significantly weaker for the quarter. Readings for retail sales and industrial production are liable to slow a further slowdown. Even if GDP growth officially holds firm, there will be growing concerns surrounding data accuracy and manipulation. These inconsistencies will be highlighted by unofficial indices of growth such as power consumption and freight traffic, which suggest the economy has weakened further than was seen during the 2008 downturn.
3. Any slowdown in China will also be a very important factor in undermining confidence surrounding Asian growth as a whole, with particular concerns surrounding export prospects. In this environment, regional and wider emerging currencies are unlikely to stage a further significant recovery, which will undermine risk appetite. There will also tend to be renewed net dollar buying by Asian central banks, which will have a significant impact in pushing the US currency higher as underlying Euro reserve accumulation remains at lower levels.
4. The eurozone is unlikely to be a harmonious unit over the next week. Portuguese political parties were unable to secure a fresh political deal late last week. After the President ordered a national unity government to oversee austerity policies with greater authority, the opposition Socialist party has so far refused to take part and has called for fresh elections. The Spanish government also remains embroiled in potential scandal surrounding illegal payments with pressure for Prime Minister Rajoy to resign. Two crucial problems for national governments across the eurozone are that support for austerity measures is continuing to drain away while the banking sector remains extremely vulnerable to rising bond yields. Higher yields will have to be countered at all costs by the ECB with the euro likely to suffer as a result.