Wednesday FX View: Bernanke Expected to Soothe Rate Expectations

by: Interactive Brokers

The dollar is marginally lower in early New York trade, which is likely a disappointment to anyone hoping for follow-through to Tuesday’s sharp deterioration in equity prices. The double-coincidence of weaker business and consumer confidence measures in Germany and the United States was enough to pull the rug from beneath ardent bulls. Initial selling pressures in the overnight Asian session failed to stick with the Nikkei and the Hang Seng indices managing a mid range close. European stocks are thinking about rallying and U.S. equity futures have turned positive. The result is that the dollar is slightly less in demand ahead of Mr. Bernanke’s testimony on monetary policy to Congress this morning.

Euro – Weakness in the euro was limited to $1.3500 compared to $1.3450 at the end of last week. And while the euro remains susceptible to further noise out of Greece, where today unions have pulled off national strikes, the bearish situation appears to be calming. There was some data released for December industrial orders today, but given the time lag and the subsequent news domination by sovereign debt issues, data is meaningless.

U.S. Dollar – As risk aversion picked up on Tuesday, selling pressure in stocks has ameliorated leaving demand for dollars a little lower. But it’s important to recognize the stage of the game we are at. Tuesday’s quite literal lack of confidence does not signal a fresh downturn but is rather a sign that investors don’t quite know where to look for growth next. Investors travelling in the rear coaches of the economic train felt the impact of a rather sharp application of the brakes by the driver. The jolt caused them to sit up and react. However, the train remains in motion and passengers are increasingly realizing that they face a slower journey as opposed to a complete standstill.

The dollar gave up some ground overnight to the Japanese yen to ¥90.04 while it eased to $1.5443 per euro. The dollar is also coming around slowly to the reality that interest rates are very likely on hold in to 2011 if comments on Tuesday by St. Louis Fed member James Bullard are in line with economic developments. He expects rates to stay on hold for that long if the Fed’s predictions for the economy hold true. Mr. Bullard also tried to develop a time frame for the use of the phrase “extended period” by saying that he’d be happy to interpret the phrase to mean rates were on hold for a period of six months. And so if the FOMC is still using those words in June, interest rates might be on hold through the end of the calendar year.

Investors will scrutinize Mr. Bernanke’s words this morning and he is widely expected to confirm that the recent discount rate adjustment was not in any way, shape of form attached to the cost of money to consumers nor business. He may even confirm Mr. Bullard’s sentiment that the spread between the fed funds and discount rate would return to at least a 50 basis point differential now that the wholesale money markets are working and that banks are showing up less frequently for emergency funding at the discount window.

Aussie dollar – The Australian dollar is making headway against the dollar in New York. Investors watching weakness in Asian markets recognize a lack of follow-through selling as investors await Mr. Bernanke’s words. If he explains away the recent discount rate increase, which he more than likely will, an extension of easy money is likely to maintain the yield cushion the Aussie commands over an above the dollar. Investors are fast warming to this fact and are once again buying the Aussie unit, which has increased to 89.15 today.

Canadian dollar – The Canadian dollar received a real grilling by the stronger greenback recently and that continues to remain the case today. It’s easy to blame the weakness on yesterday’s sharp pullback in the price of crude oil but oil remains far closer to $80 than it does to $70. The Canadian dollar buys 94.68 U.S. cents today.

British pound – The pound is recovering midweek after Tuesday’s uncomfortable session during which sterling bears clawed at Bank of England officials who were rather downbeat on the prospects for the economy. The clear threat of further quantitative easing should conditions demand doesn’t sit well with sterling bulls disgruntled by the mercurial improvement in the economy. The pound managed to rally in early trade to $1.5436 although it was weaker per euro at 87.77 pence.

Japanese yen –The yen is weaker per euro at ¥122.18 although continues to maintain gains against the U.S. dollar. Depending on how far this rush of blood continues as investors realize that U.S. monetary policy is likely to remain on hold, the yen may make some significant headway given recent losses were spurred by notions of an accelerated timetable for American interest rate increases.