USD: The two faces of Bernanke, JP Morgan’s Yates comments

Bernanke is trying to separate the concept of tapering from tightening, says vice president and global FX strategist at JP Morgan Private Bank Sara Yates.

Over the past few weeks we have seen two sides of Bernanke. First, he surprised the market by announcing that near term tapering is on the way, which caused UST yields to gallop higher and the USD to outperform a broad basket of currencies.

Whereas, his comments at the National Bureau of Economic Research (NBER) that the “overall thrust of monetary policy will remain ‘highly accommodative'” weighed on US yields and lead the USD to give up some of its recent gains. We believe the reason for his two faces is that Bernanke is trying to clearly separate the concept of tapering from tightening.

In other words, he is trying to keep the short end of the yield curve anchored while allowing longer dated yields to drift higher. This is tricky to do. It seems likely that we will see further mixed messages from the Fed over the coming months as they try to control all parts of the US curve.

With investors uncertain about which Bernanke would speak before the Financial Services Committee last Wednesday, the market was largely directionless for the first half of the week.
In the end, Bernanke’s message largely repeated the view expressed at the June FOMC meeting. The main thrust of his comments reiterated that the pace of tapering would be linked to the strength of the economy and that tapering is distinct from raising rates.

However, at the margin, the repetition of the two way risks around the outlook for tapering and the widening of the pre-conditions to include financial conditions, gave the comments a dovish air. As a result the USD came under modest pressure and stocks advanced.

With the market largely focusing on events in the US, the performance of the USD versus a broad basket of other currencies remains highly correlated. We believe this provides investors with opportunities to enter trades at better levels, in this case to go long the USD versus low yielding G10 currencies. We discuss this further in our latest FX Outlook “One
quarter, two halves”.

GBP: No collapse expected

Our long held view has been that GBPUSD will remain under pressure but will not collapse. Our strong conviction is based upon two factors. First, UK data has strengthened recently and more asset purchases (which weigh on the exchange rate) are not warranted.

Second, unlike the US or Japan, UK inflation is above target and rising. In our opinion, the deterioration in real wages (because of low nominal wage growth and sticky inflation) combined with uncertain employment prospects
have been the main reason that UK consumption growth has been so lacklustre.

As consumption is the main driver of the UK economy, economic performance as a whole has been weak. Pushing the exchange rate lower makes this worse, while having little impact on growth.
We believe last week’s MPC (monetary policy committee) minutes corroborate our view. The minutes surprised the market by showing that the committee voted 9-0 against more asset purchases at Carney’s first meeting.

The market had expected the vote to be 7-2. We believe the minutes show the MPC is moving towards using a different policy mix to
stimulate the UK economy. We continue to expect forward rate guidance to be a key policy going forward and expect to learn more about this and other potential measures to stimulate the UK economy in the August Inflation Report.

Positioning data suggests that the market remains bearish on GBPUSD. This opens up the possibility that surprises will prompt a technical rally in GBPUSD.

We do not see scope for such a rally to be sustained. The UK economy is weaker than the US and the MPC has shown they intend to use forward rate guidance to keep the short end of the UK yield curve flat and prevent financial conditions in the UK tightening on the back of rising US yields. Consequently, we like tactically selling rallies in GBPUSD. Our 1 year forecast is 1.47.

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