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Dollar Softer, Bernanke Misunderstood

NEW YORK ( BBH FX Strategy) -- The dollar is broadly weaker against major currencies, with moves still confined to recent ranges with the exception of sterling. The euro broke above the 1.3350, rising for three consecutive sessions and returning to the level at the start of the month.

Markets seem to be still reacting to Fed Chairman Ben Bernanke's comments that were, in our view, misinterpreted as dovish. Cable broke above its recent high of 1.5950, returning to levels not seen since November last year.

M&A talk is a factor, with Abu Dhabi reportedly looking to buy a third of the British government's 82% stake in the Royal Bank of Scotland, BP looking to sell North Sea assets worth approximately 2 billion pounds and Lloyds selling a 500-million-pound loan portfolio to U.S. firm Bain Capital.

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Global stocks are higher, with Asian stocks tracking U.S. equities higher following the comment from Bernanke. The MSCI Asia Pacific Index is up 2% led by gains in Japan and Hong Kong. The Nikkei has filled gap left from last year's earthquake.

European shares are higher for a third day, with EuroStoxx 600 up 0.2%, bank shares up 1%. U.S. yields are flat and yields in Italy and Spain are modestly higher, with the 10-year up 5 basis points and 2 basis points. Brazil's Vale sees significant iron ore demand from China, unlike Australian companies last week that were more cautious.

Interpreting Bernanke

Judging from the press coverage, we suspect many observers have misunderstood Bernanke's comments Monday. They need to be placed in the context of what went before, namely, several hawkish regional presidents spoke, seemingly raising the prospect of a hike as early as next year and a backing up in U.S. yields. His comments justified the continued accommodative policy as necessary to make further progress in reducing unemployment, which he argues requires a faster growing economy.

While acknowledging improvement in the labor market, his concerns were twofold: 1) that one could not be sure that the pace of improvement will continue and 2) that with high levels of long-term unemployment and the sheer number of jobs and hours worked below pre-crisis levels, conditions are far from normal. That does not mean QE3 is around the corner or about to be signaled at the next FOMC meeting as some claim. Nor do we expect the Fed to unilaterally disarm by denying itself a policy tool that it argues has been effective.
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