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Bernanke Crushes Hopes of Dollar Bulls

Kathy Lien, Director of Currency Research, GFT

The U.S. dollar fell sharply this morning on the heels of Bernanke's comments about future monetary policy.  Speaking at the National Association for Business Economics Annual Conference about the state of the labor market, the Fed Chairman crushed the hopes of dollar bulls when he said accommodative monetary policy is needed to reduce unemployment.  Despite the decline in jobless claims and improvements in the overall economy, the Federal Reserve has long been dissatisfied with the high level of unemployment.  Today, Bernanke made it clear that despite wide indications that the job market has been improving, "conditions still remain far from normal" and therefore they "cannot yet be sure that the recent pace of improvement will be sustained."  The dollar's strength in the beginning of the month was largely driven by adjustments in monetary policy expectations.  The consistent improvements in the U.S. economy led investors to believe that another round of Quantitative Easing was no longer necessary.  However, according to Bernanke, more stimulus is needed to drive unemployment lower.  In other words, if the Fed wants to turn recovery into growth, they need to keep monetary policy ultra easy.  Bernanke used the word accommodative so many times in his speech today that it left little to doubt in our minds that they will not only keep the current stimulus in place for the next 2 years but at the first sign of weakness, which can be caused by anything including higher oil prices, they will turn on the printing presses.  

Bernanke argues that the high level of unemployment is caused by cyclical and not structural factors and because of that accommodative policies would address the problem.  The recent decline in the unemployment rate is caused in part by the "reversal of the unusually large layoffs in 2008 and 2009."  If the Fed wants unemployment to drop further, it would "require a more rapid expansion of production and demand from consumers and businesses, a process that can be supported by continued accommodative policies."

Thanks to Bernanke, speculation of QE3 is back on with investors pricing in additional asset purchases on the long end of the curve because long term unemployment is what the Fed is watching "carefully."  We have often said that monetary policy expectations is the single most important driver of currency fluctuations.   As a result, this renewed dovishness from the U.S. Federal Reserve could spark a fresh downtrend in the U.S. dollar.  The EUR/USD soared approximately 75 pips on the comments, breaking 1.33 in the process. The next level of resistance for the currency pair will be its year to date high at 1.3485.  

The only thing that can save the dollar would be easier monetary policy from the ECB.  If the European Central Bank is more dovish than the Federal Reserve and acts sooner to increase stimulus, the rally in the euro would stop dead in its track.  With ECB members Weber and Noyer saying that ECB loans is not a solution to the crisis and the region may have to live with emergency measures for some time, this is not out of the question.  In the meantime, stocks  should benefit significantly from the prospect of easier monetary policy from the Fed and for the currency market, this will keep risky currencies and risk appetite steady.  Pending home sales are due for release later this morning, but we do not expect the housing market report to lend much support to the U.S. dollar.   @import url(/css/cuteeditor.css);