US Dollar Rebounds From Key Support, Bernanke Remains Complacent

The US dollar staged a solid recovery on Friday, as the dollar index bounced from key trendline support that formerly served as resistance from late 2005 – 2007. Meanwhile, Federal Reserve Chairman Ben Bernanke spoke on financial stability at the Kansas City Fed's annual Jackson Hole conference. His commentary didn’t necessarily reveal anything new, though he did say that “the recent decline in commodity prices, as well as the increased stability of the dollar, has been encouraging. If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year.” However, the rest of Mr. Bernanke’s speech was status quo, as he said “the inflation outlook remains highly uncertain” and that the “FOMC is committed to achieving medium-term price stability and will act as necessary.” Nevertheless, despite the fact that the financial health of the two US mortgage giants Fannie Mae and Freddie Mac remain a major concern in the markets, Mr. Bernanke said nothing about them. It appears that when it comes to that sensitive issue, Mr. Bernanke will allow US Treasury Secretary Henry Paulson to do all the talking.

Looking ahead to next week, the US dollar faces heavy event risk as S&P/Case-Shiller home prices, consumer confidence, durable goods orders, and Q2 GDP revisions will all hit the wires. However, the minutes from the Federal Reserve’s August meeting may be the event to watch, especially if the commentary signals any sort of bias within the FOMC.

British Pound Falls Over 200 Points As UK Economy Stagnates

The greenback was strong across the majors on Friday, but was especially so against the British pound as UK GDP was revised down significantly. Indeed, GDP unexpectedly stagnated during Q2 and led the annualized rate of growth to slow to a 16-year low of 1.4 percent. UK expansion was plagued by a 5.3 percent drop in business investment, the first decline in household spending since 2005, and a contraction in industrial production for the second consecutive quarter. While the Bank of England has made a point of discussing their concerns about the upside risks to inflation and intent to maintain price stability, it’s worth wondering how long the central bank is willing to stand aside as the economy falters. The markets are betting that it won’t last for much longer, as Credit Suisse overnight index swaps continue to price in over 50bps worth of rate cuts within the next 12 months. However, I believe that they will wait until the end of the year, if not 2009 before taking such action.

Euro Down But Not Out – Buying Opportunity?

The Euro fell nearly 100 points due to broad US dollar strength and as Euro-zone industrial new orders fell for the second consecutive month in June. Meanwhile, Credit Suisse overnight index swaps have actually shifted to price in just under 25bps worth of cuts within the next 12 months compared to 31bps yesterday. Furthermore, on an intraday basis EUR/USD remains with in a bullish channel as the pair consolidates above this week’s lows, suggesting a Euro buying opportunity. Looking ahead to next week, there are few major indicators on hand, though some releases can spark short-term volatility including: German IFO (Tuesday), German unemployment (Thursday, and Euro-zone CPI estimates (Friday).

Gold, Oil Declines Prompt Commodity Dollar Losses – Consolidations Continue

The Australian dollar, New Zealand dollar, and Canadian dollar all fell lower as crude oil futures slumped more than $6/bbl while gold futures plummeted $9.50/oz, but when it comes down to it, AUD/USD and NZD/USD remain in consolidation mode as they trade above last week’s lows. USD/CAD, on the other hand, may have already had its breakout following a series of bullish Canadian releases earlier in the week, including retail sales and CPI. Next week, the release of the New Zealand trade balance on Monday and Canadian GDP on Friday both have the potential to move markets, but since the latter will be a quarterly release, traders should be especially wary of the number.

Japanese Yen Slips as DJIA Rallies Nearly 2%

The Japanese yen ended Friday down versus most of the majors as traders sought out risky assets, as indicated by the nearly 2 percent surge in the Dow Jones Industrial Average and sell-offs in global government bonds, which are typically “safe haven” assets. In fact, 2-year Treasury yields surged 15bps while 10-year German Bund yields jumped 10bps. As usual, the moves in the Japanese yen had little to do with Japanese fundamentals, and instead depended much more on broad risk appetite. This should continue to be the case next week even though there will be heavy event risk on hand. On Monday, Bank of Japan Governor Shirakawa will speak, and given the risk of recession in the country, traders will be looking for indications that he is considering reducing interest rates. On Thursday, Japanese CPI, the jobless rate, and retail trade numbers will all hit the wires. The inflation numbers may not influence price action too much, but the indicator should be watched as the headline index is anticipated to hit decade highs due to energy and food costs, while the core measure may barely reflect positive price growth. Indeed, once commodity prices start to fall back again, the Japanese economy will once again face the threat of deflation.

Terri Belkas is a Currency Strategist at FXCM.