Dollar Requires Valentine Lift from Bernanke
The dollar selloff of the past 2 days is reaching key support levels, which would only stabilize from an upbeat testimony by Fed Chairman Ben Bernanke.
We expect Fed chairman Ben Bernanke's testimony to offer a vital dose of support for the dollar as his message should not only reiterate the upbeat tone of the last FOMC statement, but also reflect the particularly hawkish remarks from Fed officials last Friday.
On Friday, St Louis Fed president Poole said: "If we get an upside surprise on GDP growth, then monetary policy may have to be tightened somewhat". Also on Friday, Cleveland Fed president Pianalto said: "we may see that some inflation risks remain. In that case, some additional policy firming may be needed". Finally, Dallas Fed president Fisher said he is fairly comfortable with the inflation outlook but would "aggressively" argue for further rate hikes if inflation does not remain in line with the Fed's comfort level. All of this suggests Fed officials are clearly leaning on the hawkish side of neutrality. We do not expect the Fed to pull the trigger, yet it has no choice but to maintain its rhetorical hawkishness. This should be reflected in Bernanke's testimony and the Fed's forecasts.
It also important to recall the upbeat FOMC statement of January 31, which upgraded the Fed's assessment on the housing market, by addressing the improvement as "...tentative signs of stabilization", in contrast to the December statement, which indicated "substantial cooling of housing". But instead of rallying on the statement, the dollar was sold off into the next day mainly because some market players had expected Chicago Fed president Moscow to present a dissenting vote for a rate hike. The January statement was the first unanimous decision to hold rates unchanged at 5.25% after Richmond Fed president Lacker dissented in each of the Fed's 4 meetings of 2006 when it held rates unchanged.
The other reason the dollar sold off after the January 31 decision was the statement's diminished hawkishness on inflation language, which noted: "Readings on core inflation have improved modestly", compared to: "Readings on core inflation have been elevated" in the December statement.
In sum, Bernanke's testimony will be a chance for dollar bulls to place in their bids, with the net effect being supportive for the currency rather than providing any sharp upmoves considering the strong GDP reports from the Eurozone and Germany and an expectedly strong Q4 GDP report from Japan on Wednesday evening (NY Time).
The EURUSD chart below suggests the possibility of the pair testing the 1.3075 resistance in the case of weaker than expected January US retail sales (expected at 0.3% from 0.9%), but our expectation for an upbeat speech from Bernanker at 10:00 am EST should trigger fresh dollar buying and drag the pair back towards the 1.3020s. Prolonged dollar gains may can break the 1.30 figure, but support seen building at 1.2960. In the event that Bernanke and the Fed's forecast give further reduce their preoccupation with inflationary pressures, EURUSD may sustain its bids and retain new support at 1.3020-30 and target 1.3125 -- 50% retracement of major downmove from 1.3360 high.
USDJPY daily chart suggests further selling ahead to test the 2 ½ month trend line support at 120.50, at which point we expect market cautiousness from Bernanke effect and BoJ dovishness to provide new floor. Only in the event that Fed lowers its inflation forecast and Q4 GDP rises above 0.9% q/q would pair be dragged to 120.
10 year Treasury Note
After breaking the 10-week trend line resistance, prices on the 10-year T-note (March contract) dropped back to the 106.70s, but will likely face support at 106.55 (yield faces resistance at 4.85%). A breach of this level should feed aggressive dollar optimism. From a yield perspective, traders must watch the resistance at 4.85%, while key support stands at 4.71%. A breach below 4.70% should translate into sharp dollar losses.