We warned in yesterday's note that Bernanke's speech will be key for the markets. We were not disappointed.
The U.S. dollar rises across the board after Federal Reserve Bank Chairman Ben S. Bernanke’s speech touches upon the inflationary repercussions of the weak dollar, which is a relatively rare explicit reference by Bernanke on the inflationary implications of the currency and the emphasis to support the currency. These remarks are interpreted as a major stepping up of inflationary vigilance by the Fed Chairman, which should play in the favor of the U.S. dollar into the rest of the week. The speech may sound like the Fed’s version of “strong dollar policy,” a mantra that has long emerged from the U.S. Treasury with little effect in the market. The fact these dollar supporting remarks have emerged from an institution with the means to control interest rates is somewhat an unprecedented in the current Fed and bears the signs of the central bank’s bid to support the U.S. currency. These remarks may also be part of the much talked about coordinated steps between United States and Europe to bring about stability in the U.S. currency.
Monthly FX Forecasts
EUR/USD
Last month, the main themes in the EUR/USD pair were the positive impact of soaring oil on the pair and the negative impact of the emerging change in Fed funds futures expectations in favor of a Fed hike later this year. None contained any information on Euro zone growth until the release of a stronger than expected German IFO business sentiment survey, showing its highest advance in 17 months. The report was instrumental in finding support for the once falling euro just below $1.53. But other reports did point to a slowing Euro zone: Euro zone retail sales, broad declines in consumer confidence and rising German unemployment. These reports must theoretically drag the euro back towards $1.53 to $1.52, but there are three forces that are expected to underpin the currency ahead:
Renewed upside in Euro zone inflation to 3.6% offers little choice to the ECB other than maintain its rhetorical tightness;
Upward revisions in Euro zone Q1 GDP to 0.8% quarter over quarter by the IMF and European Commission shall also embolden the ECB to step up its anti-inflation vigilance, which would further reduce forecasts for an ECB rate hike in 2008;
OPEC’s good cop-bad cop stance in their intentions to raise oil output by 500,000 and keep the market well supplied are likely to be offset by reinstatement of the notion that oil surge is a result of speculators and U.S. economic weakness.
Separately, expectations of a Fed pause later this month are unlikely to transition into the materialization of an actual Fed hike, with the more plausible scenario for the Fed to resume easing in Q3 and bring down rates to 1.25%. We have long maintained that the real U.S. economy has shown no credible improvement, except signs of stability in some data series, such as ISM and consumer spending, which require confirmation. Just like the same time last year, we expect the Fed to remain unable to put its rate policy where its rhetoric is and raise rates.
These forces are seen maintaining the status quo in the EUR/USD pair, producing a slight upward bias towards $1.5650-1.5700, with support underpinned at the major foundation of $1.5280.
USD/JPY
After emerging on a climate of improved risk appetite and reduced expectations of Fed June rate cut, the 10-week long rally in USD/JPY displays signs of peaking out, as momentum indicators suggest a prolonged flattening. The notion that the macroeconomic climate will force financial markets into a gradual return towards the March lows is likely to eliminate any expectations of Fed tightening and reopen the probability curve for 2008 rate cuts. Prolonged declines in U.S. equities are expected to drive down the pair to revisit last month’s 102.55 lows before settling near 103. We consider the modest retreat in USD/JPY as a precursor to a larger decline in August towards 100 and onto 98 by end of Q3. A Renewed spike in oil prices could act as an obstacle to our positive yen forecasts, but oil-driven moves in the Japanese currency have long proven short-lived.
GBP/USD
Sterling’s better days have mainly been limited to high inflation figures and rising oil prices, which is a USD negative. With virtually no good news on the UK economic front acting as a positive for the pair, we remain downbeat on the currency and the GBP/USD pair. Dilemmas of central bank policy in the industrialized world have rarely proven helpful for currencies, especially when economic figures have grown relentlessly worse. From mortgage approvals, to rising unemployment and looming uncertainty among banks will keep sterling pressured. The combination of such UK specific economic deterioration with overall reduced appetite is likely to accelerate losses in the still high yielding sterling. We maintain our forecast for UK interest rates to reach 4.25% by year-end from their current 5.00% despite rising inflation. The prolonged credit crunch and a weak UK consumer will convince the majority of policy makers at the MPC to shift the priority to economic growth away from the Bank of England’s government imposed inflation target.
Periodic rebounds in the pair are seen remaining mostly capped at $1.98, with a renewed slide towards $1.9550 arising by month-end. The 200-week moving average of $2.0060 is expected to serve as solid resistance, keeping the bear alive. Last week’s disappointing GDP figures from Canada (Q1 at 5-year lows of 0.3%) and yesterday’s dismal consumer confidence figures have taken over from rising oil prices as the main driver of the loonie. The figures suggest the Bank of Canada will cut rates by 25 bps to 2.75%. Reduced risk appetite and weaker US/Canadian growth have usually proven CAD negative. USD/CAD upside is especially expected to appreciate on the Fed pause/BoC rate contrast. Interim resistance to emerge at the 200 day MA of 1.01, followed by 1.0150.
AUD/USD
The overnight release of the Reserve Bank of Australia’s monetary policy decision was a reiteration of the central bank’s inflation vigilance despite its indication of tightening in financial market conditions. Slowing retail sales maybe among the convincing data series pointing to a slowdown, but prolonged increase in inflation expectations are to keep the Aussie supported, especially in the absence of any systemic risk. Our expectations for a gradual decline in equities are the principal reason why we expect the pair to end the month near present levels, rather than heading higher. Any retreat lower is expected to be supported at 0.9450 for renewed run-up towards 0.9800 in Q4.
Ashraf Laidi
Chief FX Strategist
CMC Markets US
a.laidi@cmcmarkets.com
