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.

With the link between growth and job creation looser than historical and academic models suggest, we continue to believe that it would be necessary to see either a marked deterioration in conditions, suggesting a new recession, or a re-emerging threat of deflation before a new round of asset purchases by the Fed becomes possible.


Some developments in Spain are worth mentioning. We are seeing some damage control Tuesday with promises of austerity from Spain's Prime Minister Mariano Rajoy after his unilateral adjustment to the 2012 deficit goal last month.

Rajoy noted that the 2012 budget won't be completed until March 30 and that it would be "very austere." He also promised a new reform drive after the budget is done. Yet he admitted that civil servant pay can't be cut.

Meanwhile the Industry Minister warned that consumers face a 7% increase in electricity costs April 1 as subsidies are removed, but noted that this is only part of the adjustment needed to cut the so-called tariff deficit. Fully eliminating it would see costs jump up to 40%.

Also, Economy Minister Luis de Guindos warned that Q1 and Q2 will be a "very difficult" economic situation, while the Bank of Spain said data points to GDP contraction in Q1.

Given the recessionary forces still in play, we believe that Spain will continue to miss its deficit targets. Recent bond market underperformance relative to Italy suggests that market concerns have (rightfully) shifted back to Spain. This should help cap euro gains near the 1.35 area. The eurozone debt crisis is by no means over, it is simply hibernating.


The Hungarian forint is testing the 290 level against the euro after the government announced a new 2-year lending facility and widening of collateral requirements. The measure is similar to that recently taken by Denmark offering three-year loans, which looks like a mini-Long Term Refinancing Operation.

As of April 3, banks will be able to borrow at the benchmark interest rate, thus reducing the maturity mismatch risks on their balance sheets. The catch is that the facility will be made available only to banks that commit to not reducing lending to the private sector.

This represents a big turnaround from the ruling Fidesz Party's hostile approach to banks and is part of Prime Minister Viktor Orban's charm offensive ahead of a possible large debt sale and talks with the International Monetary Fund. The signs seem to be pointing to an IMF deal, but we think this has been fully priced in. We expect trendline support near 289 level to be tested and perhaps broken in the short term as positive sentiment continues.

Still, we recommend caution as fundamentals remain weak and policy-makers face a combination of slow growth and high inflation.

The central bank meeting later Tuesday should prove to be a nonevent, with rates held at 7.0% as widely expected. However, markets will be looking for signs that the bank is tilting more dovish after one MPC member voted to cut rates 25 basis points at the last meeting.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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