• Bernanke Pleases Dollar Bulls and Offsets Weak TIC Report
• British Pound Rallies as BoE Upgrades GDP Forecast
• Yen Sells Off Despite More Promising Data

US Dollar
Just as we have promised, the combination of Ben Bernanke's semi-annual testimony on monetary policy and the TIC data delivered a great deal of market volatility.  The dollar first sold off following weaker economic data.  The $60 billion magic number that we were looking for in the net foreign purchases or TIC report was actually breached, causing a state of alarm as foreigners limited their purchases of dollar denominated securities to $56.6 billion, which was far less than the market's $76.2 billion forecast and short of the $65.7 billion trade deficit for the month of December.  Industrial production also contracted unexpectedly by 0.2 percent last month as warmer weather decreased the need for utility usage while mortgage applications took another nose dive, falling 7.3 percent after a 1.2 percent drop the previous week.  Overall, applications have fallen 11 out of the past 16 months.  The only piece of good data that came out today was the Empire State manufacturing survey, which increased modestly from 20.1 to 20.3 - the market had actually expected the index to dip.  However, the dollar's losses were completely erased when Ben Bernanke began speaking.  It was very interesting to watch the new Fed Chairman tread carefully as some members of the House could not refrain themselves from pushing for some straight answers, especially since it is the first time in 20 years that they have seen a new face in the hot seat.  It was actually quite refreshing to hear some straightforward and easy to understand comments from the Fed Chairman. Overall the questions and answer session went rather respectfully.  Bernanke said that "some" more rate hikes may be needed.  The word "some" is usually defined as more than one, so we assume that Bernanke intends to proceed with a rate hike in March and May.  He also felt that even though inflation was well contained, consumer spending could continue to fuel growth in the economy, which would ultimately lead to higher inflation and if that happens, more rate hikes may be needed.  In terms of the housing market, Bernanke acknowledged that it poses a risk to growth, but like many, he felt that a cool down is more likely than a collapse.  Overall, there were no surprises and the market got what it was looking for, which is a clearer outlook on interest rates.  However, Bernanke's time in the limelight this week is not over yet.  He is slated to speak again to the Senate tomorrow, and as usual, the question and answer session will be the most interesting. 

Euro
The Eurozone economic calendar was completely empty today with only the Italian Current Account balance scheduled for release.  According to the report, Italy's current account deficit shrank from -EUR2.15 billion to -EUR1.98 billion in December.  With no distractions, it is hardly surprising that the EUR/USD moved purely on dollar fundamentals.  Looking at the headlines in the Financial Times "Europe" section, we see nothing but bad news from "Fears for Spanish growth as soaring deficit hits EUR61 billion" to "Bird flu prompts EU to ban untreated feathers" and "Recovery hopes in Eurozone hit by German data."  Yet, don't let the press' doomsday scenario throw you off as the European Central Bank is still on path to raise interest rates by a quarter of a point in March.  We have mentioned repeatedly that the weakness in the Euro, particularly now that we are trading below 1.1900 will be extremely stimulative for the Eurozone economy.  This means that economic data is set to improve and that is what the ECB is considering when talking up rates.

British Pound
Aside from the US, developments in the UK was the other hot topic in the markets today.  To everyone's surprise, the Bank of England was a tad more optimistic as they increased their forecasts for GDP growth.  They still think that inflation will remain near their 2 percent target and acknowledged that they were unsure about how energy prices will impact inflation.  However, after seeing yesterday's weak inflation numbers, particularly the drop below the BoE's target for annualized inflation, some traders had expected the BoE to be a bit dovish.  The more neutral report on the other hand makes the outlook for a rate cut in the near future murkier, which has given some sterling bears a reason to square positions. 

Japanese Yen
Optimistic comments from Ben Bernanke has helped the dollar rally against the Japanese Yen after three days of back to back losses.  Adding even more confusion to the clash on Japanese interest rates, LDP Chief Nakagawa said that the decision to end quantitative easing is up to the BoJ. Data out of Japan continues to be positive with the leading economic index increasing to 81.8 percent, above expectations of 80.9 percent, after a large increase in November to 80 percent from 54.5 percent.  The index, which measures consumer confidence and other indicators, has been above 50 percent for four consecutive months now, signaling faster growth in three to six months.  Released simultaneously was the coincident index, which measures current economic conditions; that index checked in at 100% as expected.  January machine tool orders released an hour later suggests a pickup in business investment in machinery, checking in at 5.4 percent year-over-year versus 5.0 percent in December.  Overall, economic news out of Japan overnight was positive, but unfortunately not enough to satisfy Yen bulls. Meanwhile there is a fascinating observation made by our friend Andrew Busch at the Bank of Montreal.  He said that according to Bloomberg, Treasury Undersecretary Tim Adams "has asked strategists, investors and academics to assess the likely reaction of financial markets in the event the department cites China in its semiannual report on exchange rates," in April.  Our questions is, why would the Administration be conducting such a test if they did were not seriously considering this possibility?

Kathy Lien is the Chief Currency Strategist at FXCM.