Fed Chairman Ben Bernanke's testimony before the Senate triggered widespread volatility in currencies. When Bernanke first spoke, the U.S. dollar soared against all the major currencies because Quantitative Easing was not mentioned as a possible tool to stimulate the economy. Based on his prepared remarks, Bernanke is clearly frustrated with the pace of recovery, but he deliberately stopped short of mentioning more QE, because he knew that doing so would spark speculation of action in August, a decision that they were not prepared to make.
However, as the question and answer session began, it quickly became clear that Bernanke would not be able to avoid discussing his plans for monetary policy, and more specifically Quantitative Easing. About 20 minutes into the Q&A session, Bernanke admitted that they have a range of possibilities for more easing, including more QE, using the discount window and cutting the interest rate on excess reserves. Their challenge right now is figuring out whether the "loss of momentum in the economy is enduring." However, as the evidence shows, there is "frustratingly slow" progress on joblessness and a modest risk of deflation. This means that while August is out, QE3 is still an option for September.
When the dust settled, investors realized that nothing Bernanke said today removed the risk of additional stimulus and for the currency market this means there is no justification for a dollar rally. If anything, Bernanke's concerns about deflation should tell us that the central bank remains in easing mode. FOMC member Pianalto spoke after Bernanke's testimony, and she confirmed that the economy needs "highly accommodative monetary policy."
Bernanke's noncommittal comments on QE3 are consistent with the central bank's strategy of biding their time until there is unambiguous evidence that another round of asset purchases is necessary. Two more months of job growth less than 100k and another month of negative retail sales could do the trick.
With approximately 8 weeks between now and the September 13th monetary policy meeting, a lot could happen in the financial markets and in the U.S. economy. If Bernanke wanted, he could still signal plans for QE3 at the annual Jackson Hole Economic Summit of central bankers in late August. Both the 2010 and 2011 Jackson Hole Summits were Bernanke's venue of choice for signaling a major change in monetary policy; in 2010, Bernanke delivered his infamous speech that tipped off the market that QE2 was on the way and in 2011, he expanded the FOMC meeting from 1 to 2 days to outline the details for Operation Twist.
With very little consensus within the central bank, increasing asset purchases in 2 months instead of 2.5 weeks is far more realistic. By then, the latest FOMC forecasts would have been released, giving central bank officials a much better sense of how the economy is faring. Furthermore, the timing of the September FOMC meeting is perfect because Bernanke could use the Jackson Hole Summit to signal a potential change, make the change in September and then answer questions at the regularly scheduled post monetary policy meeting press conference.
While Bernanke will be testifying again before the House, the statement will be the same, which means that the more important release tomorrow could be the Federal Reserve's Beige Book report.