Tuesday November 17, 2009

Maybe Fed chairman Bernanke's mention of the level of the dollar was unconventional when he addressed the Economic Club of New York on Monday, but it was very much in line with what treasury secretary Geithner has been saying all along. On the one hand the government understands the fact that the nation and its international fan base benefits when the dollar is potent. On the other hand the cataclysmic events of the past two years have been a real game-changer. In order to address the consequences of those events exceptional measures must be taken in order to create a return to somewhere near what we considered normal. Acceptance of a weaker dollar in the short term as a result of an abandonment of the price of money will be countered in the medium to long term by a return to growth.

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Mr. Bernanke's comments were peppered with a cautious tone, which was dollar unsupportive. But once again while the patient might not appreciate the taste of the medicine, the benefits will become clear over time. It's that kind of subtle thought process that appears to be taking grip today as the dollar gains ground against the euro and as risen to stand at $1.4904 from $1.4974 overnight.

The Fed chairman singled out two worrisome factors for us to pay attention to over time when he discussed bank lending conditions and the labor market. These two factors may constrain the pace of the recovery. Clearly Mr. Bernanke does not want to paint too rosy a picture just yet as he warned that jobs will likely remain scarce for some time and that the impact would ensure cautious household spending.

The path to payroll growth will only open up when an established recovery is underway. Interestingly Mr. Bernanke attempted to trash-talk other opinions on the impact of temporary measures. In his opinion the performance of the economy is not based solely upon temporary measures. That's fighting talk right back at the weekend comments from a Chinese official who growled at the U.S. for rolling out its zero interest rate policy.

The overall downbeat tone to chairman Bernanke's comments has taken the shine off risk appetite overnight. Asian equity markets fell while the dollar and Japanese yen have both improved. The dollar has risen to buy ¥89.35 while the yen has gained against the euro to ¥132.85 and against the pound to ¥149.86. The dollar index is higher by 0.6% with the greenback broadly higher against all the majors.

The Aussie dollar was swept sharply lower as loss of emphasis towards riskier assets met the minutes of the latest RBA meeting at which interest rates were raised to 3.5%. Traders took the comments from the Australian central bank to be relatively dovish as they claimed postulated that the risk to the economy going forward is that government stimulus wears off. Meanwhile interest rates were said to be too low, but the fact that the RBA is addressing a near-term balance suggests a potential pause when it comes to the next meeting.

However, the real spanner in the works here is that the minutes were recorded ahead of the recent robust labor market report, which showed the unexpected addition of 24,500 jobs during October when the market had predicted a loss of 10,000. This is likely to weigh of the views of the committee when it next meets in two weeks time. The Aussie dollar meanwhile fell to 92.63 U.S. cents.

The Canadian dollar is also of course lower in line with lower risk appetite and lower commodity prices. Today the Canadian dollar buys 94.56 U.S. cents.

The pound has reversed course against the dollar this morning after having gained earlier in the session buoyed by the release of slightly worse inflation data. The year-over-year CPI data showed the first pick-up in the pace of inflation albeit marginal. The 1.5% annual change compares to an expected 1.4% change and is the first rise in eight months after a string of declines. Having traded at $1.6864 the pound now buys a cent less at $1.6764.

Bank of England monetary policy committee member, Andrew Sentance said in a speech that it was not yet time for the Bank to consider withdrawing monetary stimulus but also warned that keeping those measures in place would risk stoking inflation. In a later televised interview he said that the Bank must remain 'open-minded' about further stimulus measures.

The fact that he mentioned inflation and tied it to the prospects for further stimulus served to boost investors' appetite for the pound relative to the euro today with the euro falling to 88.63 cents.

Andrew Wilkinson

Senior Market Analyst