Will Traders Cut Dollar Positions Ahead Of Bernanke?

The most important event risk this week for the financial markets will be Bernanke's semi-annual testimony on the economy and monetary policy. Following last week's dovish comments and Monday's weaker than expected U.S. retail sales report, some traders may feel compelled to reduce their U.S. dollar positions ahead of the Fed Chairman's speech. According to the House Financial Services Committee, the prepared portion of Bernanke's testimony will be released at 8:30am ET on Wednesday instead of the usual 10am. Apparently "This change will allow members of the Financial Services Committee the opportunity to review the testimony and the report before the hearing begins." In other words, it will give members of Congress more time to pick apart Bernanke's plans and prepare their discerning questions. The U.S. dollar may have ended the day higher against the Japanese Yen, Canadian dollar and Swiss Franc but its losses against the Australian and New Zealand dollars and its inability to rally against euro and sterling is a sign of hesitation in the FX market. This morning's softer retail sales report gives the Fed Chairman reason to maintain a more cautious approach. Few will argue that the Federal Reserve is getting ready to taper this year, but how they choose to do so could affect the market's reaction. The central bank could always taper less or pause after a one-off move, which would moderate the market's reaction and give the economy breathing room while still moving in the direction of reducing overall stimulus.

U.S. retail sales growth slowed from 0.5% to 0.4% in the month of June and excluding autos and gas, spending contracted for the first time in 12 months by 0.1%. These numbers indicate that consumer spending will contribute very little to GDP growth in the second quarter. The largest decline was seen in building materials but Americans also spent less on electronics, food and beverages, department stores and other miscellaneous items. Despite the pickup in job growth, consumer appetite has been muted and until we get a stronger recovery in consumption, the Federal Reserve will need to be very careful with how much stimulus they remove from the economy this year. Manufacturing conditions in New York on the other hand improved in the month of July. The Empire State manufacturing survey rose to 9.46 from 7.84, a sign that the sector is continuing to recover after contracting in May.

The retail sales report will give Bernanke greater motivation to sound more cautious dovish at his semi-annual testimony on the economy and monetary policy before the House on Wednesday and the Senate on Thursday. While we doubt that the Fed has changed their minds about tapering this year, Bernanke will spend most of his time in Washington reassuring Congress that their plans will not send the economy into a downward spiral. To do so, he will stress that monetary policy will remain extremely accommodative and a rate hike is a long ways away. His specific comments may not deviate much from last week but the testimony can be very market moving because tough grilling by Congress may force Bernanke to divulge more details on the Fed's plan to taper. With approximately 2 months before the next FOMC meeting, if the U.S. economy continues to recover, the central bank may become more vocal about their plans to prepare the market for a change in monetary policy and as that occurs, the process should revive the rally in the U.S. dollar. In the meantime however, the prospect of dovish comments could prompt more traders to reduce their long dollar positions ahead of Bernanke's speech.

EUR: Shrugs Off Fitch Downgrade Of EFSF
While EUR/USD tested 1.30 intraday, it rebounded off earlier lows to end the North American session unchanged. No major euro-zone data was released this morning but Fitch downgraded their rating of the European Financial Stability Facility to AA+ from AAA. The decision had very little impact on the euro because it was catch up move to downgrades made by Moody's and S&P last year. In January of 2012, S&P cut the EFSF's rating to AA+ and Moody's followed in November of the same year. The issue for all three rating agencies is France. Fitch downgraded the country's long term issuer debt rating last week and was prompted to adjust the rating of the EFSF because its rating is based on the guarantees of euro area member states and the deterioration in the credit quality of France reduced the quality of the facility's rating. The German ZEW survey of investor confidence is scheduled for release Tuesday and based on the recent volatility in the financial markets, disappointments in euro-zone data and dovishness of the ECB, we wouldn't be surprised if investors grew less confident about the outlook for the German economy. The ZEW survey is the most important euro-zone release this week and could be fairly market moving for the euro. Meanwhile producer prices in Switzerland increased 0.1% in June. With inflationary pressures relatively muted, the impact on EUR/CHF was nominal.

GBP: Summer Discounts Expected To Drive CPI Lower
Like the euro, the British pound ended the day unchanged against the U.S. dollar. In the month of July, house prices grew at its slowest pace since January according to Rightmove PLC but on annualized basis, prices increased at its fastest rate ever. The agency said "the combination of apparent economic stability internationally and some signs of an economic upturn nationally mean more home movers are willing and able to increase their financial commitments. Barring a raft of bad negative news, we expect the positive impact of this on the property market to continue." The outlook for the U.K. housing market remains promising but it is one of the stronger and not weaker parts of the economy. U.K. consumer prices are scheduled for release Tuesday and inflationary pressures are expected to drop for the first time since January. According to the British Retail Consortium, shop prices fell for the second month in a row by the largest amount since 2007. At the time, the Director of the BRC said "the strong deflation in non-food item prices was due to summer sales as retailers compete for customer spending. "The volatile weather also had a part to play in pushing down non-food prices. It's telling that the categories which saw some of the deepest discounting - clothing, footwear, furniture and DIY - were those whose sales were hit the hardest during the lingering cold snap." The same factors that drove the BRC shop price index lower is expected to drive CPI down as well. Soft inflationary pressures allow the Bank of England to keep monetary policy easy.

AUD: RBA Minutes Pose A Threat To Aussie
Monday night was shaping up to be a busy one Down Under with New Zealand consumer prices scheduled for release along with the minutes from the most recent Reserve Bank of Australia monetary policy meeting. While New Zealand CPI could tick higher because of rising food prices, we do not expect the RBA minutes to support the A$. When the central bank last met, dovish comments from RBA Governor Stevens sent the Australian dollar tumbling to fresh lows. At the time, Stevens said, "We have to negotiate the downward phase of the investment boom over the next few years, which appears likely to pose significant changes.....confidence seems pretty subdued right now.....Much depends on confidence - that intangible thing that is hard to measure and very hard to increase." A weaker currency hasn't brightened their view instead Stevens said a lower Aussie is needed for Australian business to compete as the country transitions from a commodity boom. As a result, we feel that the RBA minutes poses a threat to the AUD even though the Australian and New Zealand dollars were spared Monday from further losses against the greenback after mixed Chinese economic reports. China's economy grew by 1.7% in the second quarter, which was stronger than Q1 growth but weaker than expected. Also on an annualized basis, Chinese GDP growth slowed to 7.5% from 7.7%. Industrial production also grew by only 0.5% in June compared to 0.7% in May. Yet the AUD and NZD rallied because retail sales was strong with growth reaching 13.3% year over year up from 12.9% and the service sector proved to be surprisingly resilient thanks to recent tax reforms. So while the Chinese economy has slowed, there are bright spots, which was enough to stem the slide in the commodity currencies and avert a pullback in the global markets. However with this in mind, the Chinese government predicts that growth will slow to 7% this year, which means they expect the economy to continue to lose momentum in the second half of 2013.

Yen To Take Cue From Risk Appetite
The Japanese Yen traded lower against all of the major currencies Monday. Markets in Japan were closed for a holiday overnight but that did not stop global investors from driving the Yen lower. This week is a quiet one in Japan with no major economic reports on the calendar. However, as we saw in Monday's price action, the forex market doesn't need Japanese data or even the participation of Japanese traders to move the Yen. We know that the Bank of Japan is committed to easy monetary policy and uneven Chinese growth only gives them a stronger reason to keep the liquidity flowing. Yet with Japan's economy continuing to improve in the eyes of the central bank, there is no major motivation to increase stimulus in the immediate future. So the outlook for the Yen hinges on the performance of the Nikkei and U.S. bond yields along with Japanese appetite for foreign bonds. Tokyo Condominium sales is the only piece of Japanese data expected for release over the next 24 hours which means the Yen will take its cue from the market's overall risk appetite.

Kathy Lien, Managing Director of FX Strategy for BK Asset Management.