Bernanke’s Dollar Bounce & Soaring SHIBOR

<p>The dollar rose following Fed Chairman’s Wednesday pronouncements that the tapering of asset purchases may begin this year and could end altogether by June of […]</p>

The dollar rose following Fed Chairman’s Wednesday pronouncements that the tapering of asset purchases may begin this year and could end altogether by June of next year. It was the Bernanke opening remarks (not the FOMC statement), which shed light on the possible timing of the start of the tapering, something never expressed before by the Fed Chairman.  We did not expect Bernanke to introduce a time reference to a possible slowdown in purchases, which made the notion of tapering a question of “when” and not “if”.

We are not yet certain that the Fed will eventually taper this year, but as we stressed throughout this year, USD strength shall remain our principal theme going forward as it had prevailed over the past 5-6 weeks (interrupted by short-lived corrections). The Federal Reserve is the G5 central bank deemed most capable to carry out any sort of gradual withdrawal of asset purchases than is the ECB, BoJ or the BoE.

Note that Chairman Bernanke had clearly indicated in the past the condition for tapering is “evidence of sufficiently strong and sustained growth”. The point of contention then becomes over what constitutes “strong and sustained growth”. Private economists are starting to issue their own formulas; such as 2 more job reports of +150-200K in NFP and no monthly gains in unemployment by more than 0.1%.

Fed officials lowered their forecasts for the unemployment and inflation rates this year. The unemployment rate outlook was reduced to 7.2% to 7.3%, compared with 7.3% to 7.5% in their March forecasts. The 2014 unemployment forecast was dragged to 6.5% to 6.8% from 6.7% to 7.0% in March. Thus, the Fed’s unemployment projections are moving in the right direction towards a taper.

Bernanke said the central bank may start reducing bond purchases later this year (September or December), before ending them in the middle of 2014 if the economy continues to improve according to the central bank’s forecasts. As for rate hikes (not to be confused with lowering asset purchases), 15 of 19 policy makers said the federal funds rate will be raised in 2015 or later. This number rose from 14 in March.

What if?

The most important element to determining a Fed taper this year shall remain the accompanying data and market climate. If the projected decline in US unemployment does materialize, and the jobless rate drops below 7.0%, then will the Fed truly be able to reduce purchases to say, $70 bn or $65 bn even if a new global economic reverberation strikes.

- What if the IMF does suspend aid payments to Greece if Athens fails to the €3bn-€4bn shortfall in its last bailout?

- What if there is a complete seizing of China’s credit markets?

The latter may have been on many permabears’ radar for 2-3 years, but the latest rates action in China merits close scrutiny. Rates in China’s interbank funding market (Shanghai Interbank Offered Rate) began soaring earlier this month on concerns with slowing foreign-capital inflows and drying liquidity in banks’ coffers, prompting funding costs higher. The People’s Bank of China noted the spike in rates was a result of excessive reliance on short-term borrowing by some banks and these must not rely on continuous liquidity drives from the central bank. We should expect mounting speculation of interest rate cuts by the PBOC as well as possible easing in the minimum reserve requirement ratio, which had not been cut since May 2012. Combining the stresses in China’s banking system with ultra-low rates in Australia, the case for going against the Aussie remains strong. AUD is already the worst performer this year, down 11% against the USD, underperforming even the Japanese yen. FX traders with more creativity, can consider getting on the dips in EURAUD and capping the bounce in AUDCHF.

Build your confidence risk free
Join our live webinars for the latest analysis and trading ideas. Register now

StoneX Financial Ltd (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.