EUR Continues Recovery
The euro continues to make headway as a combination of auctions and positive moves in periphery debt markets provided an additional tailwind, on the back of Bernanke’s comments yesterday. On that note, we continue to question whether the market has been overemphasizing individual phrases contained in the Chairman’s speech, rather than looking at the broader context. If the Fed truly believes that cyclically weak aggregate demand is behind the disappointing state of the labour market, then accommodation is necessary via countercyclical measures. Many of these are already in place and not once did Bernanke hint that additional measures would result in the acceleration of aggregate demand recovery. In other words, it appears markets are interpreting the Fed is shifting back towards a more dynamic policy framework, but there are conceptual problems with this view: even with unchanged/static policy, the response mechanism in the real economy is still a dynamic process and it does not appear the Fed is looking to disrupt the equilibrium in the short-term, and this applies in both directions. The markets’ natural impulse to any form of QE talk is always to sell the dollar and load on risk, but to acknowledge the dollar as a growth currency on the back of improving data is not afforded the same level of conviction, which leads to the asymmetric price action we are seeing. Although the Fed is probably justified in remaining cautious and warning the market in holding off on its expectations pricing for normalization, ultimately this will need to be communicated at the right forums and pre-judging upcoming FOMC decisions under the new communications framework is premature. Overall, forward policy will remain highly data-dependent, and this applies holistically as the Fed is well aware the new risks to the US economy could well arise from exogenous shocks, and there are many potential candidates out there. One other interpretation for a more conservative Fed at this point is simply to discourage a stronger dollar – if QE is proving politically contentious anchoring normalization expectations is the next-best-thing. However, this could prove contentious both domestically and globally so the market still needs to acknowledge the risks behind being over-dependant on the Fed shifting course, especially if that’s the only thing holding risk up. EURUSD traded 1.3327-1.3385 and USDJPY 82.65-83.03.
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