• Dollar Bulls Tread Carefully Ahead of Bernanke Speech
• More Reasons for the ECB to Raise Rates
• Rumors of Central Bank Bidding in USD/JPY Sends Currency Higher

US Dollar

After a week of straight losses, the US dollar recovered a bit of its strength against the majors today.  The commodity currencies suffered the most with the Australian dollar falling 0.9 percent and the New Zealand dollar sliding a whopping 1.6 percent.  The Canadian dollar also fell, but the losses were limited.  This suggests that carry trade liquidation appears to be the predominant theme in the markets since it seems far from a coincidence that Australia and New Zealand are also the only two major countries who have higher interest rates than the US.  The economic calendar is light today with only the release of leading indicators for the month of February.  The report came in slightly stronger than expected, falling 0.2 percent compared to a forecasted 0.3 percent drop.  However, the prior month's report was also revised down from 1.1 percent to 0.5 percent.  The market is treading carefully ahead of Federal Reserve Chairman Ben Bernanke's speech on "Reflections on the Yield Curve and Monetary Policy" later this evening (The speech is scheduled for 19:00 EST).  This will be the Chairman's last chance before the FOMC meeting next week to clarify his stance on monetary policy. The FOMC typically moves into a "quiet period" the week before the interest rate announcement.  Last week, expectations for 5.00 percent rates were pared back significantly.  The market is now only pricing a 70 to 75 percent chance of a quarter point rate hike in May compared to a 90 percent chance the prior week.  Today, we are seeing some dollar bears cash in profits ahead of Bernanke's speech.  However judging from Bernanke's previous testimonies as Fed Chairman, we think that he will choose to stick to the script, don his professor cap and talk more about where the yield curve should be based upon math models than drop hints about how much further the Fed will raise rates.  Yet anticipating the unexpected, dollar traders should be keeping an ear out for anything that may sound more hawkish or more dovish.  Next week's quarter point hike has been completely discounted by the market, which means that we will be looking for significant changes to the FOMC statement.

Euro

The Euro shrugged off stronger economic data and hawkish comments by both ECB Chief Economist Issing and President Trichet.  The single currency has already rallied significantly last week on the same themes that today's data reinforces, which is stronger growth and rising inflation pressures.  German producer prices jumped by 0.7 percent last month.  This brought the annualized growth to 5.9 percent from 5.6 percent, a 24 year high, instead of dropping to 5.3 percent like the market had initially forecasted.  This prompted the ECB President to warn again that inflation is above their 2.0 percent target which means that the central bank is still looking to raise interest rates.  Issing confirmed the ECB's near unanimous view by suggesting that the central bank stands ready to act if necessary on curbing inflation.  Meanwhile Switzerland also reported stronger numbers.  Industrial production rose 6.9 percent in the fourth quarter after falling 3.2 percent before that.  Growth is improving and like the ECB, the Swiss National Bank also delivered a quarter point rate hike this month. 

British Pound

The British pound ended the day virtually unchanged against the dollar, but slightly stronger against the Euro.  The government's finances were better than expected last month while money supply ticked higher.  Collectively, the data supports the Bank of England's on-hold stance.  Over the past 2 weeks, UK economic data has been showing strong signs of improvements, suggesting to some that if this trend continues, 4.50 percent rates may be the bottom in the UK.  Unless merger and acquisition activity continues to pick up however, the British pound's strength against the Euro and US dollar will probably remain limited.  Either way you cut it, the interest rate spread between Eurozone-UK rates and US-UK rates is narrowing against the pound's favor.  In fact, the Fed's much expected rate hike later this month will turn long GBP/USD into a negative carry trade.

Japanese Yen

Although the Japanese Yen attempted to extend its gains against the dollar, the rally was short-lived as USD/JPY snapped back quickly after touching the 115.50 level.  The rumor is that there may have been central bank buying at that level. Hawkish comments from Bank of Japan member Mizuno helped the Japanese Yen recuperate some of the losses later on.  Although, he warned that a premature rate hike was bad for the economy and that rates will probably remain near zero for the immediate future, the market chose to latch onto his view that it is "not too early for a monetary policy change."  Also helping the Yen was speculation that with US Senators visiting China, they may be pressured into loosening their currency again this week.  We think that this is highly unlikely, but by the same token if USD/JPY continues to weaken, rumors of central bank bids and intervention will escalate.  There are only a limited number of ways for the Japanese government to manage tightening monetary policy with keeping the Yen weak and one of the easiest is to instill the fear that they may intervene to artificially weaken the currency either by words or actual actions.

Kathy Lien is the Chief Currency Strategist at FXCM.