USD Weighed on Bernanke`s Assessment

Fed Chairman Ben Bernanke said the outlook for the economy has worsened in recent months and that downside risks to growth have increased. He provided a somber assessment of the housing market, labor market and credit conditions, adding that conditions could worsen more than anticipated. Bernanke expects sluggish growth in the near term but anticipates a stronger pace later as monetary and fiscal stimulus trickle into the economy. He emphasized lags in monetary policy and that stance should be assessed in light of medium term forecasts and risks. Further, Bernanke sees overall CPI easing from recent rates and expectations remain anchored. He said the Fed would closely monitor inflation expectations. Bernanke’s comments reinforce market sentiment that the FOMC will maintain its easing stance, saying it would “act in a timely manner as needed to support growth and to provide adequate insurance against downside risks”.

The dollar fell against the euro and sterling, slipping to 1.4647 and 1.9736, respectively. The greenback was unable to sustain earlier gains following better than expected US economic reports as hints of further interest rates cuts from the FOMC weighed on the currency.

The data included weekly jobless claims, which eased to 348k down from 356k a week earlier. Meanwhile, the December trade deficit shrunk by more than estimates, falling to $58.76 billion, compared with calls for a decline to $61.5 billion from $63.12 billion in November. Also, the deficit with China fell to $18.79 billion versus $23.95 billion from November.

Weak US Data Drags USD

The dollar eased further versus the euro and sterling following another round of weak US economic data, falling to 1.4708 and 1.9722, respectively. A key indicator of consumer confidence fell to its lowest level in 16-years with the University of Michigan preliminary sentiment survey dropping to 69.6, versus 78.4 from January. Industrial output in January crept up marginally to 0.1% versus a flat reading in December. Meanwhile, capacity utilization also increased slightly to 81.5% from 81.4% a month earlier. Also released was the December net capital flows (TIC), which more than halved to $60.4 billion, versus a revised $150.8 billion a month prior.

The string of soft US data reinforces fears that the economy is headed toward a recession, thereby prompting the Fed to aggressively ease rates over the coming months. Fed funds futures contracts reflected a 60% probability for the FOMC to cut rates by 50-basis points to 2.50% at the next policy setting meeting in March.

AUD Rallies on Hawkish RBA

The dollar is weaker against the euro and Aussie as the US market returns from holiday, falling to its lowest level in 3-months versus the Aussie at 0.9236 and a 2-week low against the euro at 1.4756.

The NAHB housing market index unexpectedly rose to 20 in February, versus 19 a month earlier. Nonetheless, despite the improvement, the index remains mired near record lows. Traders will turn to US economic data slated for release on Wednesday, which include January CPI, building permits, real earnings, and housing starts. Consumer prices in January are largely unchanged, with monthly headline CPI at 0.3% from 0.4% and 4.2% versus 4.1% from the previous year. The core readings are seen at 0.2%, unchanged from a month prior and 2.4% y/y, also unchanged.
The Aussie rallied to its highest level since November against the greenback at 0.9236 following the release of the minutes from the Reserve Bank of Australia’s February meeting – in which the RBA hiked interest rates by 25-basis points to 7.0%. The minutes reinforced market sentiment for further policy tightening over the coming months and revealed consideration from Board members for a more aggressive 50-basis point hike in February. The rationale for a more aggressive move was deterioration in the inflation outlook and “the risk of inflation expectations becoming dislodged had increased”. The RBA added that “a significant further rise in the cash rate could be necessary” on the premise that “the current cash rate in real terms arguably was noticeably below what might be expected given the economy’s circumstances”.

Fed Lowers Rates...Again

Today, the Federal Reserve Bank lowered interest rates for the second time in as many weeks, bringing its benchmark federal funds rate down to 3.00%. The Fed has now lowered rates by 2.25% since August. The move came as a relief to investors, who now see that the Fed is serious about preventing the economy from slipping into a full-scale recession. However, it remains to be seen whether the rate cuts will provide the necessary boost to the economy or instead prove too little too late. As far as the Dollar is concerned, the rate cuts carry two (conflicting) implications. On the one hand, the economy and stock market could rally, which would likely be matched by a Dollar rally. On the other hand, the interest rate differential between the US and EU is now a 1% and risk-averse investors hungry for yield will be hard-pressed to justify shifting capital to the US. The New York Times reports:

Many economists are far from convinced that even a combination of tax rebates and cheaper money would prevent a recession. And in a sign that bond investors are fretting that the moves could lead to higher inflation, yields on 10-year and 30-year Treasury securities edged up slightly on Wednesday.

USD Drifts Lower, JPY Gains

The dollar slipped against the euro and sterling at the start of the week, drifting to 1.4576 and 1.9528 amid a dearth of US economic data. Meanwhile, the yen continued to benefit from heightened global risk aversion, edging higher against the euro at 154.29 and sterling at 206.78.

The G7 Finance Ministers meeting provided little news for fx traders, reiterating its stance on China to increase currency flexibility but refraining from singling out the dollar’s weakness. Further, the ministers stressed that exchange rates should reflect economic fundamentals and that excess volatility and disorderly movements are undesirable. The communiqué stated they would “closely monitor developments and take appropriate actions, individually and collectively, in order to secure stability and growth” in the economies.

Why the Fed Cut Rates

It seems self-evident that the Fed is easing monetary policy because it is trying to stimulate the economy and shore up confidence in capital markets by making credit less expensive. Dig a little deeper, however, and a more nuanced picture begins to emerge. Conspiracy theorists believe that the Fed knows something that investors don't, perhaps that the subprime mortgage situation is more serious than the public is being led to believe. Accordingly, the theory goes, it is trying to prevent a complete collapse of the financial system. Another theory holds that the Fed is cutting rates because it has nothing to lose by doing so. Inflation is still low, from a historical standpoint, and the Fed may be trying to inject liquidity into the financial markets before it is too late. Yet another theory holds that the Fed is deliberately targeting a weak Dollar and high commodity prices, as the former benefits the US directly by narrowing the trade imbalance, and the latter benefits the US indirectly by helping emerging market economies, which are relatively more dependent on commodities. The Chicago Tribune reports:

An increase in exports was one of the positive features of Wednesday's disappointing fourth-quarter report on U.S. gross domestic product. The cheaper dollar is a major factor in export growth, both in terms of current sales and expansion of overseas market share by U.S. manufacturers.

USD Resilient to Dismal Payrolls

The dollar shrugged off a dismal labor report in early Friday trading – slipping initially following the release, but rallying sharply after traders digested the news. The greenback fell just shy of a fresh all-time low against the euro at 1.4954 before surging to 1.4788 while pushing the sterling beneath the 1.97-level to 1.9655.

The non-farm payrolls for January unexpectedly contracted by 17k, considerably worse than calls for an increase of 80k – and shrinking from an 18k increase in payrolls in the previous month. The unemployment rate, however, improved to 4.9%, drifting from 5.0% a month earlier. Average earnings edged up by 0.2%, but down from 0.4% previously, while the average work week was marginally lower at 33.7 hours. Also released today were January manufacturing ISM, which defied estimates for a decline to 47.3 from 47.7, instead improving to 50.7 and the University of Michigan consumer sentiment survey, improving to 78.4 from 75.5.