Dollar flexes muscles before Bernanke pep-talk

Earlier losses for the dollar were reversed in early New York trading ahead of Friday’s long-awaited pep-talk by Fed Chief Bernanke. However, very few analysts expect his words to set the world alight in Jackson Hole. Last year the announcement of the Fed’s preparedness to act if conditions worsen was taken as a clear sign that QE2 was coming. That hint snowballed in to a series of discussions among economists and even a survey from the New York Fed polling Treasury dealers on what size they predicted, what impact it might have on yields. All we can really expect to walk away from the speech with is shorter odds of the likelihood of further easing.

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U.S. Dollar – Thursday’s jump in the dollar accelerated when selling picked up across German equities amid rumors that authorities might enact a short-selling ban and that the leading European nation was on the verge of a ratings downgrade. It appears that a large institutional investor was positioning (or exiting a sizeable short position) on the eve of the Bernanke speech. This morning those gains had earlier given way to the lingering fear that more easing remained a possibility, which most concur is a dollar negative. If Bernanke unveils an array of additional policy tools, which the FOMC alluded to in the August press statement, currency investors will quickly try to assess whether these would be a better alternative to asset purchases, which they claim increases the supply of dollars. Watch out for the Chairman to highlight that while growth has turned out slower than hoped, we’re still in a better place than a year ago. And by proving the inflationary implications of quantitative easing the risks to further easing are higher than before. But as a necessary evil, the Fed stands prepared by its bed to act should the situation worsen.

Japanese yen – Prime Minister Naoto Kan finally agreed to step down as Japan’s leader after the final pieces of his legislation were passed. His 14-month rule was shattered after by a lack of crisis-management leadership. Finance Minister Noda is now likely to battle with other contenders next weekend to claim the top ministerial position. The Nikkei newspaper also said that the government would on Monday announce new measures to aid the economy and counter a stronger yen. Weakness in global stocks ahead of Bernanke’s speech saw the yen surge to ¥76.56 on Friday.

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