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Markets like what they heard from Fed Governor Ben Bernanke yesterday and the extension in the risk rally has gathered speed this morning. After a slight pullback where we saw the dollar stabilise earlier, it is once again coming under pressure. However, the dollar index is down nearly 6% since the end of July and it is starting to look extremely oversold so be aware of a sharper pullback in the near term. This would not mean that the rally is over, merely that the market has over extended itself with dollar shorts and some of these may be squared up as investors take profit, especially as we head into the weekend. As we saw in 2010, the market initially sold the dollar sharply on the back of the November announcement of QE2 before reversing course for the following four weeks. After that we saw the dollar fall and risk assets rally for the first half of 2011. So the greenback may not go down in a straight line from here.

Bernanke's fundamental approach

The Fed's decision yesterday rooted the longevity of QE3 to economic data, particularly data relating to the labour and housing markets. The question is how weak are these sectors? The market has run with the Fed's "unlimited" purchases and this seems to be enough to propel risk assets higher. However, the Fed also lifted its forecasts for growth and inflation yesterday, factoring in the effects of the latest round of stimulus. Thus, QE3 may not end up being as aggressive as some may think, especially if the economy picks up in the coming months.

The chief risk now is that other central banks follow suit and try to adjust their monetary policy to keep up with the Fed. The central banks most likely to act in our view are the Bank of Japan, the RBA and the RBNZ. The Japanese authorities have warned against yen strength when USDJPY dips below 78.00, it is currently at 77.90. The Japanese Finance Minister has already said that monetary policy decisions must take account of events overseas. The BOJ next meet on Wednesday, it is now reasonable to assume that the BOJ could announce an extension to its Asset Purchase Programme, so expect some volatility in USDJPY In the coming days.

Don't forget Spain...

Watch out for the Eurogroup meeting in Cyprus today and tomorrow. An ECB official has already denied a report from a Dutch newspaper that Spain is about to request a EU300bn sovereign bailout. There is the chance Madrid may apply for funds, we put the probability of that happening at 30-40% right now. However, we believe that PM Rajoy will prefer to wait and see if bond yields continue to drop, making the need for a bailout less immediate. Spanish 10-year bond yields remain within the "safety zone" at 5.6-5.65%.

Keep on top of economic data

Ahead today, watch out for US retail sales and CPI data at 1330BST/ 0830 ET. Post yesterday's Fed meeting, US data points are now going to be major market moving events. Analysts polled by Bloomberg expect another strong reading for retail sales and for core CPI (looked at by the Fed) to drop back to 2% from 2.1%. Uni. of Michigan consumer confidence is also expected to fall back to 74.0 for September after 74.4 in August. If the estimates are correct then this data is fairly anodyne and supports more QE from the Fed.

One to watch: Gold

For those who didn't jump on the band wagon directly after the QE announcement last night it can be frustrating to see such big moves take place without you being involved. However, it's always hard to trade through big announcements when the outcome is uncertain. You may have missed the boat this time, but there are always pullbacks where you can get back on the wagon and, hopefully, ride the rest of the wave. When it comes to QE gold tends to be a big mover. We see a move above $1,800 in the coming days and would look to enter a long position on a pullback to $1,765, targeting a breach of the $1,799 double top from March 2012. Above there $1,860 comes into view in the medium-term.

Gold: weekly chart



Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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