Thursday July 22, 2010

There are two ways to take the words of the Fed Chairman. You can join the crowd of Chicken Littles running through the streets screaming that the sky really is about to fall. Or you can take his promise to act further on policy at face value and buy with both hands on the promise of more stimulus. Today's response is a reversal of the initial view. Anyone contrarian who went home long of commodity sensitive dollars is certainly ahead of the crowd with the Australian dollar vaulting to a two-month high versus the dollar overnight.

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U.S. Dollar - The unusually uncertain words from Mr. Bernanke were attached to a threat to deliver more monetary stimulus. The response was an elevation in the general level of panic sending equity prices lower and the dollar higher. But U.S. corporations are delivering strong earnings with around 82% of the S&P 500 index constituents surpassing expectations. Thursday's risk rebound looks set to punish the dollar on a weaker yield curve outlook in the months ahead. The dollar index has slumped to 82.79 this morning.

Euro - On the day ahead of the release of stress testing results, the euro has rebounded sharply. Investors seem to have concluded that the publication might underscore the health of the financial system, which has concerned them for too long. The euro rebounded from a $1.2732 low inspired by Mr. Bernanke to reach $1.2879 on Thursday after data vilified ECB President Trichet. After a recent monetary policy meeting, the chief warned that outsiders were missing the strength of a rebound within the Eurozone during the second quarter. The release of expansive manufacturing activity today once again helped cast off that gloomy view.

The Eurozone's composite PMI index reading for July rose to 56.7 with services and manufacturing equally heading further into expansive territory. Each index, however, was expected to decline in line with other readings from leading nations. The news was a surprise and along with the increasingly weaker tone to the dollar, the euro made sustainable gains. Further vilifying Mr. Trichet's stance was an increase in new orders for industrial and manufacturing goods throughout May, which grew by 3.8% on the month to stand 22.7% higher than one year ago. The euro also rose to ¥111.66.

Japanese yen - Discussion continues to center on the strength of the Japanese yen and whether authorities will intervene to cheapen it. Today the yen reached ¥86.34 before investors took profits. More government and central bank officials warned today that the excessive yen gains of late were the biggest threat to the economic recovery. However, with consumers still responding to government encouragement to spend on electrical items, the recovery continues to head in the right direction.

British pound - A strong retail sales report encouraged belief that the economic recovery is sustainable and will whether the likely forthcoming loss of public sector job cuts. The pound rose to $1.5296 before profit-taking set in. Chief economist at the Bank of England confirmed the complications to the inflation profile as a result of the VAT increase set for next year. Spencer Dale reckons inflation won't return to the 2% central target until 2011 as a result. The pound will likely win more friends as long as the recovery remains on track.

Aussie dollar - The Aussie flew overnight and reached its highest in nine weeks after investors jumped on the kangaroo having leapt through strong overhead resistance at 88.71 U.S. cents. The Aussie rose to as high as 88.98 at its best point of the day as risk aversion shone through. There was no data to inspire the move, which is likely the capitulation of several frustrated bearish bets on a risk aversion decline in the Aussie.

Canadian dollar - The Canadian dollar was also in demand as a commodity dollar this morning but faced the headwind of worse than expected retail sales during May. Forecasters called for a gain of 0.4% for the month but were disappointed by a decline of 0.2%. Sales excluding autos dipped by 0.1% having been expected to add 0.5%. A climb to 96.16 ran into trouble as the dollar slid to 95.54.

Andrew Wilkinson

Senior Market Analyst       

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