Fed Event Risk Remains In Play

by: Dean Popplewell

In the current environment, capital markets are being held captive by the smallest of expressions from key central bankers, with "Helicopter" Ben Bernanke’s appearance before Congress later today likely to dominate and test the nerves of most traders. Many expect the chairman to reiterate the point that he and his fellow policy makers will remain accommodative for an extended period despite considering paring the amount of its monthly asset purchases. The market can expect the Fed to cite any economic “soft patch” examples as a temporary off-putting reason not to wholly engage in their definition of “tapering.”

Again, the post Bernanke question and answer period will highlight the significance and power of the Fed “open mouth operations.” A high percentage of market participants would prefer to take their directional cue from the "horse's mouth" and it’s at the Q&A’s that this will most likely occur. The chairman’s prepared testimony will be released at 8:30 EDT, with the hearing to begin at 10:00 EDT. Consensus does not expect the Fed chairman to discourage the markets of the belief that tapering is likely as soon as September. With that in mind, his rhetoric may sound somewhat "dovish" as he reiterates that any change in the size of asset purchases is “dependent on the economic data and on financial market conditions.”

The "dovishness" should already be priced in the markets and any extra efforts to downplay the prospect of further monetary tightening could again see the mighty dollar trade under pressure against most currency pairs.

Again, it’s a fine balancing act that Ben has to achieve over the next two days. His message must be forthright, precise and comprehensible – with no grey areas. Bernanke will be appearing before the House Financial Services Committee for the first day of the semi-annual Monetary Policy Report. The mention of “taper” has at one time or another put each asset classes prices into a tailspin. The market reaction will wholeheartedly depend on how well "Helicopter" Ben is able to draw the distinction between “tapering and tightening” and how much he highlights reasons that support continued accommodation – somewhat similar to last week's messaging.

Ben is not expected to stray away from last week’s plot, with tapering likely as soon as September but dependent on economic data and market conditions. The market's reaction over the past five sessions saw investors lighten up on their USD positions as they reduced their own tightening expectations. At current market levels and with the same message, the FX move should not be as pronounced as before. The dollar would correctly remain under “muted” pressure against the EM currencies. Any movement from the central theme and they should expect stronger directional moves from the dollar against both the G10 and EM pairs.

The data over the past week has continued to show a global economy struggling to gain "traction." While the main releases were in China, growth in the North Atlantic economies has also remained soft. Policy makers and governments alike are wondering if this slowdown has now run its course and can they now concentrate on growth objectives. China, the globe’s second largest economy, has of late been the market's economic beacon of choice. It’s not unusual to see Chinese authorities being "coy" and engaging in a "sleight of hand" with recent economic rhetoric. There has been much discussion of the move away from “economic growth” as their key policy objective. Chinese Premier Li Keqiang said the nation would seek to keep economic growth, employment and inflation within limits, avoiding “wide fluctuations.” Again, it was not a surprise to see that Chinese authorities did not elaborate on what they deem acceptable.

Before Bernanke can get into a full stride this morning, the Bank of Canada is expected to leave their central base rate on hold at +1.0%, very much in line with consensus. The new Governor Poloz’s statement is not expected to reveal any significant changes to the conditional hawkish guidance that the infamous Carney, now head of the Bank of England, so loudly touted during a global "easing" environment. The recent mixed tone of overall data should be putting pressure on the rates market. The fixed income dealers have gone some ways to hawkish prices in two rate hikes by the end of next year. This, coupled with a yield differential (anticipating higher rates south of the Canadian border), should have the loonie on the back foot. Currently the market remains a better buyer of USD on dips, looking for the currency pair to again visit yearly dollar highs in the 1.06-1.07 vicinity.

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