Yesterday’s US dollar decline, which was almost a mirror image of Friday’s rally throws open a wider question, and points to increased uncertainty over what Fed Chairman Bernanke will say to Congress tomorrow as well as the contents of the latest Fed minutes, which are also due tomorrow. The question is has the US dollar rally run its course in the short term and could it be vulnerable to a correction with a rebound in the pound and the euro from recent five week lows. While this isn’t just a US dollar story, what Bernanke has to say tomorrow will have a big bearing on the next move, not only in currency markets, but also equity markets. It is also a big week for sterling given the stronger than expected bounce back in some of the recent economic data. Q1 GDP was a surprise coming in as it did at 0.3%, above expectations of 0.1%, and the recent better than expected March industrial and manufacturing production data does suggest that this week’s latest adjustment to Q1 could well be of the positive variety, even if many economists suggest otherwise. Another factor driving sterling sentiment is also likely to be the release of the latest minutes from the most recent Bank of England rate meeting. While many market watchers don’t expect too many surprises, one particular dynamic could well surprise with respect to the voting intentions of the three doves on the committee. These three of Fisher, King and Miles, have all called for an extra £25bn worth of QE. In light of the recent improvement in UK data could one or more of them be tempted to reverse their calls for this extra stimulus? Any change here towards a slightly more positive tone and there is certainly evidence of one, given last week’s inflation report, could push back expectations about the need for further QE and underpin the pound in the short term. This morning’s UK inflation numbers do appear to suggest that inflation pressure is starting to ease, however this could well unravel if the pound were to weaken markedly as a result of speculation about further easing measures, as import costs would inevitably slow down any decline in pricing pressures. While recent improvements in UK data have the potential to push back speculation about further QE, these benefits have been offset by speculation about the likelihood of the Federal Reserve starting to taper its asset purchase program from the current $85bn a month, which has pushed the pound down against the US dollar. While many FOMC members have gone on the record as saying that the Fed needs to start looking at some form of program, or exit strategy, it has been notable that the main noise has been coming from non-voting members of the committee. The voting members appear to have been remarkably quiet on the issue. This could either be a deliberate ploy on the part of the Fed to test the temperature of the market on whether there is an appetite for such a policy as we head into 2013, or it could be symptomatic of an ideological debate within the FOMC about the diminishing returns of the open ended nature of such a policy. We are likely to get some additional colour tomorrow, but in the meantime US markets continue to make new highs. Judging by the current market movements, equity markets seem fairly relaxed about the prospects for tomorrow, continuing to move higher, while the US dollar has also rallied quite strongly, as bond yields continue to edge higher. The key level to watch on the US treasury yield is around the 2% level, which needs to be overcome to suggest further US dollar strength, and any fall back towards this month’s lows at 1.62% is likely to translate into US dollar weakness. Judging by yesterday’s price action we’ve seen some evidence of a potential change in sentiment on the US dollar vis-à-vis the recent declines in the euro with a sharp reversal of Friday’s decline. This potentially bullish reversal suggests that traders remain a little nervous about being overly short of the single currency despite the poor economic fundamentals. An improvement in the latest manufacturing and services PMI data from France and Germany this week, as well as the final revision of German Q1 GDP and the latest IFO data could well keep a floor under the euro with the key support being at Friday’s lows at 1.2800. It’s a similar story with the pound though yesterday’s reversal isn’t anywhere near as conclusive even if the momentum indicators are relatively oversold. To continue the recent rebound we need to hold above last week’s lows at 1.5160, and push beyond the 1.5300 level to retarget a move towards the 1.5410 area. A move below 1.5160 reopens the risk of a decline to the lows last seen in April at 1.5035. One thing seems certain, any move in either the euro or the pound is likely to be driven more by what Bernanke and the Fed say tomorrow than anything else, given future monetary policy expectations in Europe and the UK, and the likelihood is that he won’t say anything too hawkish given the patchy nature in US economic data and this could limit the potential for further US dollar upside in the near term. The material (whether or not it states any opinions) is for general information purposes only, and does not take into account your personal circumstances or objectives. Nothing in this material is (or should be considered to be) financial, investment or other advice on which reliance should be placed. No opinion given in the material constitutes a recommendation by CMC Markets or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person


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