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Dollar: Bernanke Takes The Stage

Last updated 2/23/2010 5:27 PM ET (GMT -5) 23 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• DOLLAR: BERNANKE TAKES THE STAGE
• EUR/USD: GERMAN BUSINESS CONFIDENCE SLIPS
• GBP/USD: BOE CONFIRMS ADDITIONAL EASING POSSIBLE
• AUD/USD: BATTELINO STILL OPTIMISTIC
• USD/CAD: DOVISH COMMENTS FROM SENIOR OFFICIALS
• NZD/USD: OIL AND GOLD PRICES PLUNGE
• USD/JPY: BOJ CAUTIOUS ABOUT INFLATION AND ECONOMIC OUTLOOK

EXPECTATIONS FOR UPCOMING FED MEETINGS

DOLLAR: BERNANKE TAKES THE STAGE

Risk aversion has taken hold of the financial markets today with currencies and equities sliding across the board.  The U.S. dollar strengthened against every major currency except for the Japanese Yen which confirms that flight to quality has driven investors into the safety of U.S. dollars.  The biggest losers were the commodity currencies which fell victim to the sharp slide in oil and gold prices.  Weaker economic data from the U.S. and the Eurozone weighed on the markets for most of the trading day and it will now be up to Federal Reserve Chairman Ben Bernanke to restore confidence.  

All Eyes and Ears on Bernanke

The last time Bernanke spoke was on February 10th, days before the central bank announced their discount rate hike. At that time, the Fed Chairman laid out their exit strategy which includes narrowing the spread between the discount rate and the target fed funds rate along with the sale of assets on their balance sheets through reverse repurchase agreements and plans to offer term deposit facilities that would be similar to certificates of deposits that banks offer retail customers.  The Fed’s message back then will most likely be no different from their message tomorrow.  Earlier this month, Bernanke said any changes they make to the discount rate should be viewed as further normalization of their lending facilities and should not be interpreted as signaling any change in the outlook for monetary policy.  This is exactly what the Fed repeated after the discount rate hike. In an effort to avoid triggering a sharp reaction in the financial markets, Bernanke could repeat this message as well which may be a disappointment for dollar bulls.  Based upon his track record, Bernanke will most likely err on the side of caution.  However outside of a negative reaction for the dollar against the Japanese Yen, it is unclear how the dollar could react against other currencies such as the euro and British pound.  Most likely, both good and bad news will help the dollar.  If Bernanke is more dovish than the market expects, the dollar could rally on risk aversion.   However if he remains hawkish and warns of additional normalization in the near future, the dollar could also rally as the outlook for U.S. interest rates brighten.  When it comes to trading U.S. data, USD/JPY is still the best bet because it tends to have the most logical reaction.  The Fed Chairman’s semi-annual testimony is always a big event for the forex markets because the central bank governor will be asked tough questions about the economy and monetary policy. This is especially true at this critical juncture of monetary policy. 

Consumer Confidence Plunges

Today’s economic reports may give the Fed yet another reason to remain dovish. Consumer confidence fell sharply in the month of February, offsetting the rise in the Richmond Fed index. With the confidence index falling from 56.5 to 46, consumer sentiment deteriorated to the weakest level since April. American consumers grew more pessimistic about the labor market and less optimistic about current and future conditions. Despite the sharp sell-off in the dollar against the Japanese Yen, the deterioration in confidence was telegraphed by the decline in the University of Michigan survey earlier this month. With the U.S. economy still losing more jobs than what is being created and grim reports about how millions of unemployed could face years without jobs, it is hard for consumers to be optimistic. Meanwhile house prices also fell 0.2 percent in December according to S&P/CaseShiller which is a tad discouraging. However the decline is not significant enough to raise red flags about the housing market. In addition to Bernanke's speech, new home sales will also be released tomorrow, leaving the state of the housing market in focus.

EUR/USD: GERMAN BUSINESS CONFIDENCE SLIPS

The euro came under additional selling pressure after the German IFO report fell from 95.8 to 95.2 in the month of February.  Although manufacturing activity has been strong, service sector activity has not.  The weakness in retail was largely responsible for the sharp decline in business confidence.  Poor weather conditions have also been blamed for the weakness in consumer consumption and if this is true, it should be temporary.  Based upon the uptick in the expectations component of the report, German businesses expect activity to pick up modestly.  Yet Germany’s economy minister does not necessarily share this sentiment.  According to Bruederle, the country still does not have a self-sustaining recovery.  Ifo economist Abberger believes that growth in the first quarter will be stifled by weather and weaker economic activity.  Meanwhile consumer demand was also weak in France with consumption falling by 2.6 percent in January, the sharpest decline since January 2008.  The decline in demand was primarily affected by the government’s decision to cut incentives for new car purchases.  The final release of German GDP numbers are due out tomorrow and no revisions are expected. Eurozone industrial new orders on the other hand are expected to be weak.  

GBP/USD: BOE CONFIRMS ADDITIONAL EASING POSSIBLE

The British pound is at the cusp of falling to a new 9 month low against the U.S. dollar.  There was no U.K. economic data released today but dovish comments from Bank of England officials confirm our fear that the pound could be the worst performing G7 currency this quarter.  According to monetary policy committee member Miles, the central bank’s decision to leave the Quantitative Program unchanged was a close call.   Bank of England Governor Bean was not as pessimistic as some of his peers but he also said it may be necessary to expand Quantitative Easing especially if growth in the Eurozone falters.  Although the BoE previously suggested that additional QE was possible, most people did not think that it was probable. Their belief was that the BoE was simply keeping their options open. Yet the string of dovish comments this morning suggests that they are actually very serious and much closer to increasing stimulus than most traders may think. If last week's economic data is a guide, then they certainly need to do more to support the economy. Bank of England Governor King even likened themselves to Greece with the only primary difference being that the U.K. has its own currency. Central bank officials also went to great lengths to talk about how a lower sterling will boost growth. Therefore it is clear that the BoE is banking on a weak currency which suggests that they will do all that they can to keep it weak for the time being, so don't expect the GBP/USD to turn around anytime soon.

AUD/USD: BATTELINO STILL OPTIMISTIC

The Australian, New Zealand and Canadian dollars were also victims of risk aversion.  Of the 3 major currencies, the Aussie fell the least as the comments from Reserve Bank of Australia Battelino provide support for the currency.  According to Battelino, the economy is still running on all cylinders and the rise in Australian dollar is a good thing for the economy.  More specifically, he said the mining boom that is currently underway could last beyond 2020 and the boom is expected to lift investment and terms of trade more than in the past.  He also believes that the growth potential of China and India suggests that the demand boom will also last longer.  Therefore monetary policy needs to be extremely disciplined at this time because every past mining boom has fueled inflation.  As a result, the rise in the Australian dollar is important because it is helping to contain inflation.  In other words, not only will the RBA raise interest rates again but they also want the Aussie to rise.  Canadian policymakers on the other hand are on the completely opposite side of the spectrum.  A senior government official said overnight that Canada’s recovery is still fragile and with so many Canadians still out of work now is not the time to change the course on stimulus. The Bank of Canada has previously pledged to maintain interest rates at 0.25 percent until at least June.  In the meantime, Australia is the only commodity producing country with economic data on the calendar tomorrow - consumer confidence and wage costs are due for release.

USD/JPY: BOJ CAUTIOUS ABOUT INFLATION AND ECONOMIC OUTLOOK

For the third consecutive trading day in a row, the U.S. dollar has fallen against the Japanese Yen.  The sell-off today was the largest on both a pip and percentage basis since February 4th.  Japanese Yen crosses have weakened across the board despite concerns about Toyota’s impact on the economy and dovish BoJ minutes.  Next to the Bank of England, the Bank of Japan is probably the least likely central bank to raise interest rates.  According to the minutes from the last monetary policy meeting, a number of central bank officials warned about the need to be cautious over the pace of recovery in consumption.  They also said short term price expectations have declined which confirms that Japan is still a long ways from winning the deflation battle.  The Japanese government has already pointed out that deflation and worsening job conditions pose risks for the economy.  This suggests that they are not going to unwind their monetary stimulus anytime soon. There was no Japanese economic data released overnight but trade balance figures are due for release tomorrow.  

USD/JPY: Currency in Play for Next 24 Hours

The currency in play for the next 24 hours will be USD/JPY. Later this evening Japan will announce its Trade Balance figures at 23:30GMT or 6:30PM EST. This will be followed by the U.S. New Homes Sale report will be released at 15:00GMT or 10:00AM EST. The sharp sell-off in USD/JPY today has taken the currency pair out of the buy zone and into the range trading zone which we determine using Bollinger Bands.  Given the degree of the sell-off, USD/JPY should trend lower and test the first standard deviation Bollinger Band at 89.50.  A break of the 91.00 would be needed to negate today’s move and resurrect the rally in USD/JPY.  

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Comments (23)

kristalen

February 23, 2010 at 09:23 PM ET

Hi Kathy ,
first thank you for the help with all the data that you and everybody at fx360 are providing for us. You guys are the best !!! thank you !!!

In the comments in your article " Dollar: Why It Is Not Threatened By Euro Rally" i read :


rmsulemanFebruary 19, 2010 at 10:25 PM ETK, what is fixed @ 12:00 EST in NY?

klienFebruary 22, 2010 at 09:51 AM ETA Fix is when banks set an official reference price, often on a daily basis, for the trading of a particular commodity or currency. This fixed price is used for anything that requires exchange rate transactions

so my question is - where can i find out about that reference price for a given day , and having that price in mind is that some kind of a central pivot point for that day ???

klien

February 25, 2010 at 09:29 AM ET

It isn't as significant as you think it is. The fix usually is usually published on Bloomberg and Reuters terminals. I am not sure where you can get it besides that

kristalen

February 23, 2010 at 10:34 PM ET

p.p. ...... and is there a corellation to the option expiry for the month

FXDragon

February 24, 2010 at 02:44 AM ET

Is there a logical explanation to when dollar strengthens against other currencies, it loses to yen?

Best regards,

MoneyManager

February 24, 2010 at 04:23 AM ET

Yes. Both are considered "funding currencies" (currencies that have a low interest rate yield, and thus are *BORROWED* by traders willing to take on risk so that they can then invest this money in other currencies that have a higher yield, or in other vehicles such as commodities).

When risk aversion strikes (fear about the growth/recovery theme), these trades are unwound, meaning that people who have made them have to BUY both the dollar and the yen to REPAY the loans in those currencies that they have made.

So "dollar strength" means nothing, really, because it has to be qualified as to "strength against X".

Right now, dollar strength means strength against everything EXCEPT the yen. Eventually that correlation is likely to break down. But until it does ...

FXDragon

February 24, 2010 at 06:54 AM ET

So right now is yen more of a funding currency than the dolla' since it gains more value on risk aversion? I thought carry trade party was crashed anyway.

MoneyManager

February 24, 2010 at 07:18 AM ET

The carry trade party crashed, big time, more than a year ago. But when the markets bottomed in March of last year it came roaring right back.

I can't quantify which is the bigger funding currency. Perhaps others can. There is also the "self-fulfilling-prophecy" aspect to consider. Namely, when risk-aversion rises, people have been making money selling the USDJPY pair, and this has gone on for some time now. So they will likely continue to do that until it stops being a money-maker.

I would guess that more and more carries are shifting from the dollar to the yen, because it seems less likely that the BoJ will tighten than the Fed, although neither is in any hurry at all. So that probably means there is a ton of borrowed yen out there that has been sold for higher yielding stuff.

FXDragon

February 24, 2010 at 07:58 AM ET

I dont know. I just wouldnt carry trade much since usdjpy is in a downtrend. We would wait for a bull market and a pull back in eurusd. Like in mid 2000s.

schultzz.at

February 24, 2010 at 07:59 AM ET

I think the Fed's exit strategy is credible, but its implementation will be performed slowly. I do not expect any news from Bernanke's testimony. The Fed will end its MBS purchases only in March and they will want to see how the market works after they have stopped their massive intervention.
If mortgage rates remain stable, they could become more confident in using the deposit rate and reverse repos to withdraw liquidity.
Tom Schultz.

fxpro888

February 24, 2010 at 04:02 AM ET

. If Bernanke is more dovish than the market expects, the dollar could rally on risk aversion. However if he remains hawkish and warns of additional normalization in the near future, the dollar could also rally as the outlook for U.S. interest rates brighten

SO BUY THE DOLLAR NO MATTER WHAT!

Whats silly is traders' reaction to the news... just buy the dollar ...and you will 'make money'

FXDragon

February 24, 2010 at 08:02 AM ET

I wonder if a forex broker would go bankrupt (god forbid!) if most traders sold eur and gbp with high leverage.

wwwin

February 24, 2010 at 04:33 PM ET

Well the USDJPY is back to where it was before 10:00 a.m. so I don't think traders were so disappointed with Bernie. It appears that th new homes sales is what brought down the pair....in addition, Bernie did mention that interest was going to be charged on reserves...meaning easing out of QE...dollar should go up more in my opinion.

idontusecharts

February 24, 2010 at 09:19 PM ET

the brokers would never go bankrupt because they hedge against u to protect themselves.

FXDragon

February 25, 2010 at 02:16 AM ET

What kind of hedge? How do they do it specifically?

Best regards,

alexjbrandt

February 25, 2010 at 03:13 AM ET

FCM's or Brokers will always take the opposite position that you place, to reduce their exposure. I have always thought of this to be a conflict of interest between the client and the FCM, but I may be wrong.

FXDragon

February 25, 2010 at 05:05 AM ET

If youre true and if i was short eur since december and so they are long to hedge. That would mean they are in double trouble right? How is that hedging?

schultzz.at

February 25, 2010 at 05:46 AM ET

The business of a broker is to match orders and collect the spread. In a quiet market this is a safe business and before major news announcements they can widen the spread.

I prefer to use the term 'hedge' in its original (narrow) sense, i.e. offsetting a risk I would otherwise have to carry because the earnings of my company are dependent on commodity prices or forex.
It's usually the responsibility of a company's Treasurer to decide about hedging.

I would advice BMW, Daimler, BASF and the likes to put on their EUR/USD hedges fast, otherwise their earnings will suffer and they will disappoint stockholders.
Tom Schultz.

alexjbrandt

February 25, 2010 at 05:50 AM ET

Yes, that means that they would have a losing trade. I think they trade against their clients, cause most lose money. And by trading against that, the FCM ends up making money overall (on top of the spread). Also probably it is what causes "stop hunting". Again, I may be wrong as I don't know how a FCM works exactly, but all FCM's have a dealing desk. However, I do know that if you don't want to be traded against, then I would recommend a ECN firm such as Dukascopy, highly recommend!

alexjbrandt

February 25, 2010 at 06:28 AM ET

Hey Tom,

Any opinion on the upcoming SNB meeting on March 11? I've noticed that the EUR/CHF is pretty much trading near levels it was at this time last year when they met and it rallied 600 pips...odds of it doing again this year?

schultzz.at

February 25, 2010 at 07:20 AM ET

Hi Alex, thanks for the Dukascopy link.
I would not bet any money that the SNB will be able to talk the EUR/CHF back above 1.50. Seems like they intervene at odd hours (Their last intervention seemed to have happened on Feb 5 during Far East trading hours). These moves hurt traders on both sides of the market.

I think the environment has changed compared with a year ago. Nobody would have considered the default of an euro area country as a valid scenario in March 2009. This has definitely changed and investors' demand for the relative safety of the swiss franc is not surprising.

I have completely removed the EUR/CHF from my quote list, but I am planning to go long in USD/CHF, preferably near 1.07, as I expect quotes above 1.10 before long. If the SNB says something like 'franc strength has become excessive, we will again counter any upside move', I will say 'merci'. If not, my disappointment will be limited.
Tom Schultz.

FXDragon

February 25, 2010 at 03:35 PM ET

I guess any broker would go bankrupt if most traders kept winning right.

alexjbrandt

February 25, 2010 at 08:11 AM ET

You make some good points, I myself do not actively trade the EUR/CHF but I keep an eye on it as any SNB intervention impacts two pairs I do trade such as USD/CHF and EUR/USD. I do agree with your target on USD/CHF, its been confined to a bullish trend channel.

FXDragon

February 25, 2010 at 09:40 AM ET

You might have to wait for long to catch 1.07 on chf buddies.
Anyway does that Dukascopy require 50,000 minimum? And any specific advantage compared to a regular fx company?

Thanks,

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.