US Dollar
Being a Federal Reserve Chairman is difficult, but being a new Fed Chairman in an environment where growth is slowing, inflation is rising, the housing market is showing signs of weakness and geopolitical risks are widespread is even harder.  For the second time ever, Ben Bernanke delivered his semi-annual testimony on the economy and monetary policy.  He was ripped apart by members of Senate that blatantly criticized his performance and his lapses in judgment thus far as well as questioned whether he was ready to take on this much responsibility.  Too bad Ben could not blame it on the curse of the new Fed Chairman.  On a more serious note, in a bid to rebuild his credibility, Bernanke stuck to the less hawkish tone that we saw back in late June.  He traded growth for inflation by confirming that a slowdown in consumer spending and the housing market are already underway.  Even though inflationary pressures are rising and remain a main concern for the Fed, Bernanke feels that the effects of past interest rates hikes are still in the pipeline and as such, do not necessitate an overly aggressive stance.  A pause in rates is near and Bernanke’s latest comments certainly hint that it may come sooner rather than later, but before getting too excited, he stopped short of slamming the door on another rate hike.  Instead, he repeated that any further moves would be data dependent.  There is a risk of overshooting interest rates, but there is also a cost for allowing inflation to get out of hand.  Expectations for an August rate hike have been pared back significantly and if this later on proves to truly be the end of Fed rate hikes, then it could also be the beginning of a long term dollar downtrend.  In the meantime, what the Fed will do next is still a guessing game. Bernanke’s comments were slightly less hawkish, but inflation reports continue to remain strong.  Headline consumer prices accelerated by 0.2 percent, which was right in line with expectations, but core rates came out stronger than expected, rising by 0.3 percent in the month of June.  This brought the annualized pace of core rate growth from 2.4 percent to 2.6 percent.  Before Bernanke spoke, the combination of a strong PPI report yesterday and a strong CPI report today actually sent the dollar soaring as the probability of a rate hike in August jumped to 80 percent.  Bernanke will be speaking again tomorrow and even though his testimony will be the same, the question and answer session will not, therefore keep an eye on any surprises. 

Euro
After six straight days of weakness that took the Euro down to a 10 week low, we finally saw meaningful gains for the single currency.  The last time we had such a long stretch of weakness was back in early June at which time the accompanying bounce lasted for three days.  Taking a look at the strength of today’s rally, it would not be surprising to see the same scenario unfold over the next few days. Data from Eurozone this morning was very mixed.  Producer prices in Germany came out strongly for the month of June confirming the higher inflationary conditions that we have been seeing worldwide.  The Eurozone trade balance however was wider than expected.  Although the surplus with the US and the UK increased, higher energy prices boosted the region’s import bills.  A similar deterioration was seen in the trade balance report from Italy today as well.  Aside from a French consumer spending report, the main events on the Eurozone economic calendar are now behind us until next week.  With inflationary pressures growing the market still expects the European Central Bank to raise interest rates next month. 

British Pound
Thanks to broad based dollar weakness, the British pound has rebounded for the second consecutive day.  Despite more neutral minutes from the latest monetary policy meeting, the strong inflation numbers reported yesterday still have some pound bulls holding out for another rate hike later this year.  The monetary policy committee voted 7-0 to keep policy unchanged at the beginning of this month and repeated earlier comments from the central bank that inflation expectations have edged lower rather than higher and they did not feel that the inflation outlook shifted much from June.  Instead, they noted that there are risks in both directions.  Unlike the Eurozone, there are still a number of important UK economic releases due out this week including retail sales tomorrow and GDP on Friday.  A weak retail sales report would offset some of the bullish sentiment that has built up in the pound after the yesterday’s inflation report. 

Japanese Yen
Once again, the performance of the Japanese Yen was very mixed today with strength seen against the US and Canadian dollars, but weakness against the Euro and British pound.  The lack of any Japanese economic data limited the Yen’s rise in the face of broad dollar weakness.  Some traders took comfort in the rebound in the stock market, which has been underperforming for the past week.  The Bank of Japan will be releasing the minutes from their June 14 to 15 monetary policy meeting tonight but we think that the release should be a non-event since the much awaited rate hike by the central bank has already happened.   In addition, the BoJ has made their intentions clear to the markets.  For at least the next 1 or 2 months, they will probably not be delivering any additional rate hikes.  In fact, they are so concerned with a sharp rise in lending rates that they injected funds into the treasury market overnight.

Kathy Lien is the Chief Currency Strategist at FXCM.