US Dollar: Fed Chairman Bernanke Jumps on Hawkish Bandwagon, Finally Notes Dollar Weakness

The US dollar rocketed higher on Tuesday following a speech by Federal Reserve Chairman Ben Bernanke, in which he issued hawkish commentary and finally commented on weakness in the national currency. Indeed, Bernanke ended any existing debate that the Fed would cut rates in June, as he said that “policy seems well positioned to promote moderate growth and price stability over time.” Unsurprisingly, he noted the upside inflation risks associated with the surge in commodities. However, it appears that there is now a fear within the Fed that the public’s long-term inflation expectations will rise, and “could ultimately become self-confirming,” as consumer face rising prices everywhere from the gas station to the grocery store. Furthermore, Bernanke even brought the US dollar into focus over a month after the currency tumbled to record lows versus the euro. The depreciation of the currency has been a contributor to the jump in import and consumer prices, but with the US Treasury highly unlikely to intervene in the foreign exchange markets anytime soon, Bernanke’s dollar comments should be taken as nothing more than lip service. Looking ahead to Wednesday, the greenback faces event risk from ISM services, and traders should watch this market-moving number to see if it manages to hold above 50 to signal expansion in the sector.

Euro: Euro-zone Retail Sales Could Prove To Be Disappointing On Wednesday

The euro started the European trading session on a strong note on Tuesday, only to have its rally against the US dollar cut short following a speech by Fed Chairman Ben Bernanke (see above). Euro-zone GDP accelerated faster than initially estimated in the first quarter on the back of jump in investment and construction spending in Germany. Indeed, GDP rose 0.8 percent from the fourth quarter due primarily to a revision to investment, which showed a 1.6 percent jump, the best reading since the second quarter of 2006. Meanwhile, the Euro-zone producer price growth outpaced forecasts, as the index rose 0.8 percent in April and jumped 6.1 percent from a year earlier. Inflation remains a major issue globally, and this will clearly weigh on the minds of the ECB’s policy makers this week. Nevertheless, the central bank is expected to leave rates unchanged at 4 percent, but traders shouldn’t write off the potential impact of hawkish commentary by ECB President Jean-Claude Trichet following the rate announcement. Looking ahead to tomorrow, the final reading of Euro-zone services PMI for May will be released. However, it is the Euro-zone retail sales index for April that the markets should watch, as unexpectedly weak spending in the German retail sector during the same period suggests that the broad European release could be similarly disappointing.

British Pound Sees Fundamental Road Bumps Ahead Of The BoE Rate Decision

Concerns that Bradford & Bingley’s financial problems could send the UK credit and housing markets reeling have clearly died out over the past 24 hours; but the damage has already been done with the pound now consolidating nearly 200 points below the week’s open. A few notable economic indicators have crossed the wires through Tuesday’s session. In early London trading, the construction activity indicator from the Chartered Institute of Purchasing and Supply sank more quickly than expected. In fact, according to the indicator activity contracted the most since records began 11 years ago. This indicator follows the already severe decline in home prices and mortgage applications and further confirms that the UK housing sector is in the same situation as its US counterpart – just nine months back. Much later in the day, the Nationwide consumer confidence survey for May crossed the wires with its own disparaging air. The sentiment report similarly hit record lows (this one going back to 2004) as Brits responded to evaporating home values, rising lending costs and soaring inflation. For Wednesday’s session, the PMI services and BRC consumer inflation reports will struggle to rouse volatility from the pound with most fundamental traders looking ahead to Thursday’s BoE rate decision.

Japanese Yen Looses Steam As Risk Aversion Settles, Data Approaches

Monday’s market-wide unwinding of risk and carry positions lost steam into the early trading hours of this morning. This pull back in demand for yen comes as fear that the UK’s Bradford & Bingley would catalyze the next leg of the ongoing credit crunch have clearly died down as the lender has yet to report any problems with liquidity (unlike the Northern Rock and Bear Stearns episodes). Instead, the Fed continued with its effort to snuff out financial turmoil with another scheduled $75 billion TAF auction and comments from Chairman Ben Bernanke that the outlook for the world’s largest economy was improving and rates would likely be held steady going forward. On the fundamental front, activity was otherwise muted. The BoJ reported a 0.9 percent drop in the monetary base to further highlight the lack of meaningful inflation throughout the Japanese economy. Looking ahead though, event risk will pick up with the Ministry of Finance’s capital spending report for the first quarter. A historical market-mover, this indicator has lost some of its sway recently. However, after the surprise strength in the preliminary 1Q GDP reading, the expected five-year low from the investment indicator may be more influential.

Commodity Dollars: RBA Holds Rates, Keeps Its Hawkish Tone

All of the com pair’s lost ground Tuesday as prices for crude, oil and other highly correlated commodities eased through the European and US sessions. Elsewhere, only the Australian docket was presenting substantial scheduled event risk. Action picked up in the Asian session with the release of the first quarter current account number. The broadest indicator for trading activity reported a smaller than expected increase in the deficit to A$19.5 billion. Far more important for the high-yielding currency was the RBA’s rate decision. Coming as little surprise, the central bank held rates at its 12-year high 7.25 percent for a third consecutive meeting while maintaining their concern for high inflation and cooling growth. The Aussie’s docket will finally taper off after the upcoming first quarter GDP release.

Kathy Lien is the Chief Currency Strategist at FXCM.