The Forex markets reacted swiftly and decisively after Fed Chairman Bernanke announced that economic risks have faded and implied that interest rates may have to go up to fight rising inflation.
Bernanke has always been concerned about fighting inflation. He spoke of the Fed's battle with inflation way back in January, but the financial crisis got in way and gave him no choice but to shore up the economy by cutting rates.
Earlier in the year, Bernanke urged the financial sector to start raising its own capital. This was the first sign that his focus was going to shift toward thwarting inflation. He and the Fed have exhausted all means to shore up the financial crisis and loosen up lending. His focus had to shift toward preventing runaway inflation.
Last week he stated that the Fed and the Treasury were well aware of the effects of a weak Dollar and crude oil prices. He saw what his comments did to the price of crude oil. This week he decided to come back with even stronger comments in an effort to break the oil once again.
Bernanke's counterpart at the ECB, Trichet, is already on record stating that he will raise rates in July if necessary in the Euro Zone. The question is: will the Fed match this rate hike with a hike of its own in August?
Financial traders who bet on the direction of interest rates by committing to spread positions are already factoring in the possibility of a rate hike on August 5. The sentiment rose in one day from 31% to 52%. Traders have also increased their bets that the Fed will raise rates in December from 67% to 96%.
With the Euro heading toward the low end of its 2-month range, it will be interesting to see if Trichet comes back tonight or tomorrow with even more hawkish language supporting the Euro to send it back up. This financial tennis match is expected to continue until one of these leaders hits the ball out of the park. In other words, look for the Euro to continue to trade between 1.52 and 1.60 or both sides of 1.56 until the market starts to believe either Bernanke or Trichet.
Bernanke's Comments Support USD/JPY
The USD/JPY rallied on Tuesday as the technical breakout continued. Traders cite the strong comments by Bernanke supporting an interest rate hike to prevent inflation from spreading as the main cause of the rally.
Keep in mind that a carry trade does not always mean money will go into the stock market. The money actually seeks the highest yielding asset. With interest rates rising, some traders are selling borrowed Yen to invest in safer yielding treasuries. Speculators are latching on to the USD/JPY as the interest rate differential is widening between the two countries.
The market broke out as expected through 106.42 and reached the first objective at 107.70. The next level is 109.30.
GBP/USD Feels Pressure of Strong Dollar
Inflation is being reported everywhere, which is the main reason the Bank of England refused to lower rates earlier this month. Since the U.S. is also expected to raise rates later in the year, the U.S. Dollar has become more attractive relative to the Pound.
GBP/USD traders have to watch how the market reacts at the last swing bottom at 1.9362. The last rally from this bottom attracted big selling up at 1.9852. Traders may try to push the Pound through 1.9362 this time to put pressure on the low of the year at 1.9336. A further decline could take the market to 1.9181, the low on March 5, 2007. A break through this area will change the trend to down on the long term monthly charts.
There may be a technically driven short-covering rally on the first test of 1.9362, but look for a selling opportunity if the market trades back to 1.9620.
Swiss Franc Reverses on Close
News that the U.S. may raise rates sooner than expected is weighing on the Swiss Franc. For the past two weeks, the USD/CHF has been trading lower as the value of the Swiss Franc has been firming in anticipation of an interest rate hike later in the year.
Two recent reports out of Switzerland are indicating the possibility of inflation. On Monday, a report citing a low level of unemployment and last week's inflationary news has been putting pressure on the USD/CHF.
With the U.S. now expected to raise rates as early as August instead of December, Swiss traders have been adjusting their positions to accommodate this change. Swiss financial market traders had been trading for a hike in Switzerland in December.
Look for the USD/CHF to firm against the Dollar over the short-run, but do not expect the trend to change to up on this move.
Bank of Canada Shocks the World by Leaving Rates Unchanged
It looks as if the Bank of Canada has been reading the papers or trying to imitate their big brother. On Tuesday, the Bank of Canada did not lower interest rates at all after the market had been screaming for a minimum 25 basis point cut.
Weak economic reports have been driving the financial markets in Canada to forecast a 25 to 50 basis point cut. The Bank of Canada on the other hand may have been reading the newspapers and seeing that inflation was up everywhere. Last week and yesterday’s comments by Bernanke and Trichet may have scared the Bank of Canada into leaving rates unchanged in anticipation of rate hikes in the U.S. and ECB.
With the Canadian economic reports signaling a rate cut, the fact that the Bank of Canada left rates alone leads one to believe that some unknown outside factor is influencing them. Canadian Bonds reacted to the news in a big way by selling off substantially.
RBA hints that Rate Hikes May be Over; Look Out Below if .9485 Fails
The Reserve Bank of Australia implied recently that demand is down so the need to raise interest rates has dissipated. Traders immediately lightened up positions on this news and the market broke.
In a delayed reaction, Australian Dollar traders put more pressure on the downside as they reacted negatively to Treasury Secretary Paulson's comment regarding intervention to help the Dollar.
These two news events have caught many traders on the long side as they expected the market to breakout over .9655 in anticipation of a new 25-year high following last week’s strong news.
This market could be in serious trouble if .9485 is penetrated.
NZD/USD Falls On U.S. Intervention Comments
The already weak New Zealand Dollar felt more pressure following Treasury Secretary Paulson's comments regarding the possibility of inflation.
This threat coupled with bad unemployment numbers and a weak housing market brought more sellers into the market on Tuesday. Breaking support could be a sign that a major top is forming especially if the U.S. and the Euro Zone start raising rates.
The charts indicate a move to .7536 is likely over the near-term. Look for resistance to sell at .7742.
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