April 2: Bernanke Testifies Before Joint Economic Committee (13:30 GMT; 09:30 EST)

What Are The Markets Facing?

On Wednesday, Federal Reserve Chairman Ben Bernanke will testify on the economic outlook before the Joint Economic Committee of Congress. Bernanke’s comments tend to spark volatility not only in the forex markets, but also in the equity and fixed income markets. Why? Risk trends. At this juncture, the biggest market-mover for global assets tends to be related to the Federal Reserve (interest rates, inflation, the economy) and the US financial sector – and all of these points will likely be touched upon by Bernanke. However, traders will react to whatever topic serves as his main focus. If Bernanke cites inflation as his predominant concern and indicates some worries about moral hazard coming into play, as some other FOMC members have suggested, fed fund futures will likely shift quickly to cut back speculation of a 50bp cut on April 30 and instead move to only price in a 25bp reduction to 2.00 percent. On the other hand, Bernanke could keep instability in the financial markets, tight credit conditions, and major downside risks to economic growth as his primary focus. This would not only sound extremely bearish, but it would also lead fed fund futures to quickly price in more aggressive rate cuts in the near term.

Bonds – 10-Year Treasury Note Futures

Treasuries remain contained in a range between 117-17 and 119-12, but the sharp drop on Tuesday may be indicative of an impending drop toward trendline support at 115-25. Fed Chairman Bernanke’s testimony on Wednesday could shake Treasuries up if his commentary suggests a pronounced bias. Indeed, if Bernanke has a more hawkish, inflation-centric tone or suggests in any way that the FOMC will not be aggressive in cutting rates going forward, Treasuries are likely to plummet. On the other hand, a continued focus on the financial markets and downside risks to growth could lead Treasuries to rebound toward 119-12, as futures will quickly shift to price in a 50bp cut on April 30.

FX – USD/JPY

After a week of consolidating the USD/JPY pair broke out above the 20 Day-SMA for the first time in over a month. According to COT positioning, the Yen has been at a bearish extreme with overbought levels over 90 for both the 13 and 52 week indexes. Therefore, a longer term bullish trend may be underway. The recent decline in business confidence as measured by the Tankan survey provided fundamental support, as expectations increase that the current U.S. slowdown is filtering through to the Japanese economy. Traders have priced in a 56% chance that the BoJ will cut their benchmark interest rate at their next meeting in an effort to stave off a recession.

The upcoming testimony from Chairman Ben Bernanke presents significant event risk for the pair, as traders will look to gauge how much downside risk remains to the economy. The recent surprising manufacturing improvements in the Chicago PMI and ISM indexes have raised hope that a full blown recession can be avoided. If the Fed chairman can provide further comfort to worried traders in his testimony, risk appetite will increase triggering carry trades, rallying equities and extending the dollar’s gains. However, if more downside risks remains, or if there is any scent of further turmoil in the financial markets, risk aversion will prevail and downward pressure will send the pair lower erasing its recent gains.

Equities – Dow Jones Industrial Average

The Dow Jones Industrial Average’s bounce from support at the 50% fib of the rally from 11,731 – 12,622 at 12,177 managed to break through the 50 SMA as well. Typically, when we see large gains (such as on Tuesday), the next trading session is relatively subdued. As a result, the DJIA may move down to test 12,500 on an intraday basis, but could still end the day in positive territory. However, given the upcoming event risk, volatility could spike. If Fed Chairman Bernanke focuses on the downside risks to growth, the credit crunch, and instability in the financial markets, the bearish sentiment could weigh heavily on US equities and lead the DJIA closer to the 12,400 level. On the other hand, more optimistic commentary by Bernanke and confidence that the Fed’s actions over the past few months have been effective could help the DJIA continue its rally toward resistance at the 100 SMA and the February 1 high at 12,729/67.

Terri Belkas is a Currency Strategist at FXCM.