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27 August 2010

FX Closing Note: Bonds and JPY retreat after Bernanke

John J. Hardy, FX Consultant, Saxo Bank

We were right in putting the focus on the bond market and the JPY ahead of the Bernanke speech, though the reactions across equities and the rest of FX were odd to say the least. Is the market reading this thing right?

Mr. Bernanke brought little to the table in today's speech, though some could argue there was something for everyone here. While the chairman apparently tried to suggest that the conditions are right for the recovery to continue (the "preconditions" for a growth acceleration in 2011 "appear to remain in place.") On the non-traditional quantitative easing front, Mr. Bernanke had nothing at all to say, only a broad statement that the Fed "will do all that it can" and is "prepared to provide additional monetary accommodation through unconventional measures if it proves necessary, especially if the outlook were to deteriorate significantly". This last statement is an obvious hint at the potential for QE2, but the general ambiguity of his rhetoric suggests that the Fed is in wait-and-pray mode for now and there were no specifics thrown out about what future QE might look like, other than Bernanke saying that continuing to buy long dated treasuries is an option.

The market reaction was mixed relative to our expectations. We suspected that Mr. Bernanke would have little to say, and that was largely true. We expected that if this was the case, that the bond market and the JPY would sell off - that was largely true as well. USDJPY ended the day almost a figure above yesterday's close, for example. But the surprise to us was the comeback in risk appetite from this speech, which suggests the market sentiment was at least temporarily too bearish since there was nothing particularly bullish about the statement in and of itself. And with risk appetite headed up, the USD headed south, so the biggest action was actually in the likes of the old highest-beta pairs like AUDJPY, which saw an enormous pop on the day.

Assessing the reaction

Now the question becomes one of the durability of this reaction. We've crossed back above a critical inflection zone in AUDUSD (0.8860) and the equity market emphatically found support at the 1040 area again in the US S&P500. The action in EURUSD today was far more ambiguous, with a marginal new high again not holding particularly well - so the jury still out there. It is hard to understand why anything Bernanke had to say should be considered a market positive and have to imagine that this is a rally based on negative sentiment getting ahead of itself - perhaps something that will last three days to two weeks, if we're to pretend we have the ability to predict such a thing. Stay tuned...