TICS Analysis, Bernanke Outlook

By: Ashraf Laidi | Tue, Jul 18, 2006
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Net foreign capital flows into the US rose 36% to $69.6 bln in May from a revised $51.1 bln in April (initial was $46.7 bln). The $51.1 bln in net capital flows sufficiently covered the $63.4 billion trade deficit for the corresponding month.

The two main contributors to the 36% increase in the May TICS report were:

The May TICS figure overshot our forecast of $35 bln as we expected the 2.6% decline in the dollar's trade weighted and the 3.1% drop in the S&P 500 to have triggered further selling of US assets by foreign investors after initially selling in April.



The key question leading to Fed Chairman Bernanke's semi annual Congressional testimony is whether the Chairman will echo the slight downgrade in economic assessment of the June 29 FOMC statement and the extent to which he will sound off the Fed's inflation alert. The downside risk for the dollar looms large in the event that Bernanke opens his testimony via an unambiguous statement regarding the moderation of economic growth and a toning down of the Fed's inflation preoccupation. The June FOMC statement's inflation assessment was negligibly revised to "Readings on core inflation have been elevated in recent months", from the May FOMC statement's: "...the run-up in the prices of energy and other commodities appears to have had only a modest effect on core inflation". Considering the light retreat in the prices/inflation indices of the latest ISMs, Chicago PMI and University of Michigan Consumer Sentiment, Mr. Bernanke may temper his inflation assessment.

More importantly, considering that Bernanke will have the June CPI report on hand by 5 pm EST Tuesday, his inflation assessment in Wednesday's testimony will in part be in function of the CPI report and in part in function of the Fed's overall interpretation of price and wage indices.

But it's worth mentioning that even if the June core CPI echoes its PPI counterpart and retreats to the more bond market friendly 0.2% reading, the Fed's inflation outlook shall remain obstructed by the uncertain prospects for the already soaring oil prices in light of the escalating Mideast violence. So far, the only semblance of a near-term pause of attacks by Israel has come from Media speculation and not Israel itself. As long as Israel declares it will not negotiate with Hezbollah and the latter vows to continue fighting back, the outlook for lower oil prices remains uncertain.

For currency markets, the following questions stand at the top of traders' priorities:

  1. To what extent will Bernanke balance the risks of further increases in oil prices, and accentuate the moderation in US economic growth?

  2. More specifically for FX, the dollar's upside prospects will be dissected across the treasury-bound safe haven flows on one side, and the dollar's high cost of carry as well as prospects for an August hike on the other side.

Despite the dollar's considerable cost of carry, we should not undermine the role of the market reaction in the event the Fed signals an August pause. Recall how the discreet downgrade in economic assessment of the June 29 FOMC statement dragged down the dollar by over 2% vs. the euro and the yen in less than 3 days. A similar downgrade in Bernanke's testimony and the Fed's economic projections could trigger fresh dollar selling, especially given future rate hikes by the European Central Bank, Bank of England, Bank of Japan and Reserve Bank of Australia.



Ashraf Laidi

Author: Ashraf Laidi

Ashraf Laidi

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