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FX Fundamentals
By DailyFXBernanke Shifts Tone, Sending Dollar to Record Low against the Euro .To the surprise of the market, Federal Reserve… … Chairman Ben Bernanke shifted his tone ever so slightly in his congressional testimony on the economy and monetary policy.
Back in February, when he gave his last
testimony, Bernanke said that the housing market was stabilizing but now
he feels that the problems in housing could get worse before it gets
better. The Feds vocal concern about contagion indicates that “in
their books†the economic environment has deteriorated enough to begin
considering putting growth ahead of inflation. For a central banker
that wants to stake his reputation on fighting inflation, this is
significant. Bernanke also reminded us that the Feds primary focus
is on core prices and not headline prices. Even though oil prices are
rising, he felt that unless we have another big jump, core prices could
edge a bit lower. The Fed cut their growth forecasts for 2008 to
2.5-2.75 percent from 2.75-3 percent and increased their unemployment
forecasts from 4.5 percent to 4.75 percent. The central tendency for
core inflation was left unchanged at 2 to 2.25 percent for 2007 and 1.75
to 2 percent for 2008. This indicates that they expect inflation to
slow over the next year. Todays economic releases provide support to
the Feds cautionary stance. Headline consumer prices were stronger
than expected, but core prices were right in line with expectations.
Even though the gain in core was slightly higher than the rise in May,
it is only modestly so. Starts increased but building permits hit a 10
year low, indicating that housing continues to be a problem. Bond
yields and the US dollar dropped on the back of Bernankes comments,
but further dollar weakness could be limited by the fact at this point,
the Fed can do little more than raise red flags.
British Pound Breaks 2.05 on Dollar Weakness and Asian Buying
The British pound first broke the psychologically important 2.05 level
against the US dollar in the middle of the Asian trading session.
Keying off of the stronger UK inflation data reported yesterday and the
weaker US PPI numbers, Asian traders aggressively bought the GBP/USD,
taking the pair up from 2.0490 to 2.0549 in a little more than an hour.
However once European traders came into the market, they began to take
profits and initiate short positions. The correction was exacerbated
when the less hawkish Bank of England minutes were released; the GBP/USD
eventually sold off to 2.0460. Once Bernanke began to talk however,
dollar selling resumed and the GBP/USD took off once again, ending the
US trading session not far from the new 26 year high set overnight. The
reason why examining the price action is so important is because it
tells us that todays strength in the GBP/USD is driven almost
exclusively by dollar weakness and not pound strength. If anything, the
Bank of England minutes signals that even if we do have another rate
hike this year, it will not be until the latter part of the fourth
quarter, at the earliest. Yesterday we indicated that anything short of
a 7-2 vote in favor of raising rates would be construed as dovish. The
rate hike earlier this month was supported by only 6 out of the 9
members. The dissenting views amongst the monetary policy committee
members indicate that as a whole, they are not in as much of a rush to
raise rates as the market may have initially thought. This stance is
supported by further slowing in average wage growth in the month of May.
Even though the number of people claiming unemployment benefits
decreased, weaker wage growth could still hurt retail sales.
Euro hits Record High of 1.3835
We have long said that the direction of monetary policy is far more
important than the level of interest rates and today, the move in the
EUR/USD is a testament to that. The currency pair climbed to a new
record high of 1.3835 following less hawkish comments from the US
central bank. In an environment where the European Central Bank is
pounding the table about the need to raise rates, the growing chance of
a rate cut before a rate hike in the US is driving the dollar lower.
One would expect that the ECB would begin backing off given the recent
appreciation in their currency, but instead of showing any signs of
concern, Trichet warned today about that any attempts to influence the
ECB would be in violation of the EU treaty. This suggests that they are
not willing to talk down the Euro and will only do so under their own
terms. ECB council member Garganas also said yesterday that he expects
the central bank to raise rates further.
Commodity Currencies Hit Fresh Highs on Dollar Weakness
Dollar weakness has sent the commodity currencies skyrocketing to new
multi-decade highs, which have become a near daily occurrence for the
Canadian, Australian and New Zealand dollars. Gold and oil prices are
up on the day which is helping, but most of the strength is coming from
US dollar weakness since the data released from the three countries were
actually bearish. Canadian consumer prices fell in the month of June,
leaving annualized consumer prices at 2.2 percent while core prices
remained flat. Meanwhile Australian leading indicators weakened in the
month of May, there was no economic data released from New Zealand. The
outlook for the currencies will continue to predominantly dependent upon
US data. Only Canada has the potential to move on its own accord with
wholesale sales and international securities transactions due for
release.
Carry Traders Havent Given Up
Carry traders arent quite ready to give up yet. Despite the Dow
having been down over 100 points intraday, the highest yielding carry
trade currencies still managed to end the day in positive territory.
The Dow also recuperated half of its losses which suggests that the
rally could go on. The only currencies that the Japanese Yen managed to
rally against were the Euro, Swiss franc, US and Canadian dollars and
for the most part, the damage was small. Looking ahead, we expect carry
trades to continue to track the Dow.
DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com
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