Euro Treads Water Yen Weighed by Carry Flows

Talking Points

·          Westpac LEI stays above trend <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />indicating RBA will hike<?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

·          Machine Tool orders print double digit gains

·          EZ Trade Balance deficit expands to five month high

·          All eyes on Bernanke and CPI today

The major currencies spent the Asian and European trading sessions marking time ahead of todays  important testimony by Ben Bernanke in front of Congress and theUS CPI figures scheduled to be released at 12:30 GMT. Yesterdays higher than expected PPI data helped push the dollar higher against the euro as EUR/USD broke below the 1.2500 barrier. If todays CPI data produces a hot number it may well seal the deal on another 25bp rate hike by the Fed in August. Traders attention however will quickly turn from economic data to Fed speak as Chairman Bernanke takes the microphone for his semi-annual Humphrey Hawkins testimony at 14:00 GMT. With the August rate hike essentially priced into the pair, market participants will be keenly interested to see if the Chairman provides any hint of future Fed policy in his opening remarks. Specifically, most traders will want to know if the Fed still considers controlling inflation its primary task in which case 6% rates before year end are a strong possibility - or whether it will choose to pay more attention to the slowing economy and therefore possibly pause after the hike in August.

The direction of Fed policy is very likely to determine the future course of trading in EUR/USD.  With geo-political conflict in the Middle East showing no signs of resolution anytime soon, the dollar continues to receive support from safe haven flows, but the greenbacks recent strength has also emanated from anticipation of higher interest rate differentials against the other major currencies. Thats why todays  testimony by Chairman Bernanke may well prove to be the pivotal event risk of the week in the currency markets.

The interest rate differential theme continues to dominate trading in Asia as well where the yen remains weak across the board despite the recent lift of the ZIRP policy by BOJ. With BOJ refusing to signal any additional rate hikes for the rest of the year, the yens miniscule 25bp yield stands  in sharp contrast to the other majors and the unit is pressured by fresh series of carry trades. In fact, tonight the GBP/JPY cross hit an eight year high of 215 as traders increased expectations of future UK rate hikes after yesterdays surprisingly strong CPI numbers.  Until such time that BOJ signals a more hawkish posture towards interest rates, a meaningful yen rally is unlikely to materialize.

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