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Last night Ben Bernanke, Chairman of the Federal Reserve, delivered his twice yearly report to Congress where he outlined their outlook on the US economy. Due to the oblique nature of Central Bank parlance, Mr Bernanke’s speech was closely watched for any indication, however vague, that the Fed thinks the economic recovery in the US is not proceeding the pace originally thought. He duly obliged, saying that the outlook was “unusually uncertain” and stressing again that persistently high unemployment remains a real problem and is likely to remain so for an extended period. The dovish tone and increasingly cautious outlook naturally led to a reduction in risk appetite and the corresponding sell off in US equities and rise in the Dollar. Cable had a volatile days trading yesterday, just before 8am we saw a huge Sterling sell, dropping from 1.5290 to 1.5168 in a minute before recovering after reports of a fat finger or algorithmic trading problem at a bank in the Netherlands. Whatever happened, we are sure someone is seeking alternative employment this morning.
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This week is all about the euro and the approaching stress test results which will offer much needed feedback on the health of European banks. The euro has experienced a significant turn of fortune from its June 4 and half low against the USD gaining over 10 cents to test the 1.30 level. One reason that the euro has gained is simply that the market was significantly over short in the euro and naturally alot of these short investors paired their positions leading to a short squeeze higher. In addition some comfort has come back into the euro approaching Fridays stress test results as comments in the run up from members of the IMF and the ECB have been bullish - we will see! Recent gains have led to EUR/USD testing the 1.30 level and GBP/EUR falling back into 1.17 territory. The results are due out from 5pm GMT on Friday- good feedback should push EUR/USD over 1.30.
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The Euro rose significantly yesterday rising up to 1.2991 against the dollar and breaking, although briefly 1.30, a ten week high. The gains were owed to more weak data from the US where home-builder sentiment fell more than expected in July to the lowest level in over a year and comments from many of the EU countries stating their most important banks had passed the stress tests. Germany, whose sources said Deutsche Bank and Commerzbank passed the tests look set to see Hypo Real Estate, a small nationalised mortgage lender fail, and it could be the first of many banks who specify in that market. With the housing market across Europe still struggling, banks who exclusively work in that sector could have overly exposed balance sheets and be the next to require a takeover or even a bailout.
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The recent Euro surge finally ran into resistance on Friday, EURUSD briefly traded above 1.30 before falling back and now sits in the mid 1.29. This Strength will be tested over the coming week for several reasons.  Firstly, Ireland was downgraded from Aa1 to Aa2 by ratings agency Moody’s. They blame the worsening financial situation facing the government, weakened growth prospects & recognition of contingent liabilities in the SPV created to rescue the Banking system. Umbrella anyone? Secondly, Hungary was denied a credit line of €20 billion from the EU/IMF over the weekend, a very unusual step, due to a lack in confidence in the new Hungarian government’s budget plans. The Florint has weakened off, but the extreme volatility some commentators were predicting in the markets today has not materialised as yet.  Lastly, Friday sees the long awaited publication of the EU stress test results. As mentioned before in this report, the tests are designed to shore up confidence in the EU banking system. The results all boil down to credibility. If the market believes that the tests do not illuminate the health of the banks tested then expect investors to express this sentiment though selling the Euro as well as the bank stocks themselves.
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The Federal Reserve minutes released last night show the FOMC expect inflation to remain subdued over the coming months, some members even revised down their estimates due to the ongoing problems in financial markets around the world. The Fed also noted that they expect unemployment to continue to rise and now forecast that full economic recovery could take five to six years. The dovish tone and disappointing advanced retail figures yesterday, 0.5% against a forecast of 0.2%, has allowed Sterling and the Euro to push higher vs the Dollar.
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UK CPI rose by 3.2% y/y in June 2010 compared to 3.4% in May, more than the 3.1% average forecast by analysts. RPI decelerated to 5.0% in June compared to 5.1% in May. RPI-X also slowed from 5.1% in May to 5.0% in June. However, core inflation accelerated from 2.9% in May to 3.1% in June, which matched the highest reading since 1997. According to the Office for National Statistics, the biggest downward pressure to CPI inflation between May and June came from falling energy (petrol and diesel) prices. Another significant downward contribution came from clothing and footwear, where prices fell due to the June sales season.
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