European stress tests awaited, no surprises from Bernanke

European stress tests awaited, no surprises from Bernanke

Commodity bloc currencies, including the NZD continue to gain ground especially against the retreating EUR and GBP.

The capacity for policy tightening driving underlying sentiment as the AUD and CAD outperform with the NZD in tow. The message from both the RBA and BoC this week all sounds very similar in flavour to our own RBNZ. While all three central bank’s see some uncertainty in the global environment there is confidence in their domestic situation which suggests if the global situation does not deteriorate then their currencies will see increased interest rate support.

Overnight the NZD was steady, trading inside a tight 0.7150/0.7200 range as the market paused ahead of Ben Bernanke testimony to Senate Banking Panel.

Following the semi-annual testimony and Q&A the markets have faded with risk appetite lower, softer equity markets weighing on currency sentiment somewhat. As we open we can eye initial support pegged at the 0.7100 level, with resistance noted overnight closer to the 0.7200 level.

There’s data in the form of local consumer confidence to watch at 2:00pm, while from Australia comes the NAB’s Business Confidence summary for Q2.

Majors

A generally heavy session for the EUR, which for the bulk of the day continued Tuesday’s retreat against major currencies. There was a dearth of data, leaving the FX market to trade off position adjustments and what has increasingly looked like a EUR that has topped out at least for now. EUR fell reasonably quickly from 1.29 to 1.28 as the pair failed to build on gains above 1.30. ECB’s Makuch (Slovakia) let it be known he thinks there is no need for markets to speculate on ECB rate hikes until 2011.

Leaks suggesting most EU banks will pass Friday’s bank stress tests has helped build speculation the tests will not be tough enough. We suspect the market has also been growing more wary that Fed chairman Bernanke in his testimony to Congress would warn not toe as pessimistic line as markets have recently believed, with a more upbeat outlook helping the USD recover some of its recent losses. GBP saw nasty price action with an aggressive sell-off early in Europe being attributed to a trading mishit.

Minutes from the BoE’s early July policy meeting once again showed one MPC member, Andrew Sentence, voted for a rate hike. The UK market was slightly unnerved by the MPC’s view that economic growth prospects were a shade weaker, while inflation looked set to hold up for longer than initially thought.

It now looks likely that the August quarterly Inflation Report will see the MPC raise its CPI projections. That said it emerged that the MPC discussed tightening and loosening policy – the latter a new development given those who suspect the MPC may also need to return to QE later this year some ammunition.

We do not see any significant risk of a return to QE just yet with Q2 GDP due Friday likely to show growth at +0.7% close to trend levels. In his Humphrey Hawkins testimony on Capitol Hill Bernanke has in initial commentary been seen as not as dovish as some might have feared.

Though there’s plenty of caution in his message and if the economy falters the Fed would have to fully review its options. While the Chairman mentions that the “economic outlook remains unusually uncertain” there is still reference to private demand helping sustain growth and some focus on small business as a key to getting the US on a better footing.

Bernanke did not announce any particular policy changes, though he did discuss and summarise exit strategies and said the Fed when ready will begin paying banks higher rates on reserves rather than lifting short-term rates by raising the fed funds rate.

The Fed also intends to draw its portfolio down to more normal levels, with broad agreement around the FOMC table to sell some of its agency and MBS holdings, though any move would be well communicated in advance and undertaken at a gradual pace.

Bernanke surprised no one with his repeat of the line that the FOMC continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period.