Bernanke hits Treasuries, boosts dollar

Fed Chairman Bernanke’s prepared testimony expressed no hurry to scale back policy accommodation given the risks to economy recovery. However, in the Q&A session following the testimony he noted that the Fed is prepared to adjust the current flow rate of asset purchases in response to incoming data. Importantly in terms of timing Bernanke hinted that the Fed could “take a step down in the pace of purchases” in the next few FOMC meetings dependent on the data. While it is likely that many FOMC members want to see more evidence of recovery especially in the jobs market a reduction in asset purchases in Q4 is likely assuming this evidence if forthcoming. The FOMC minutes echoed this sentiment.

Bernanke’s comments and the minutes fuelled plenty of market volatility, with equities selling off after an initial rally and Treasury yields rising, with the 10 year US Treasury yield flying through the 2% level. Commodities dropped and the USD strengthened, with USD/JPY breaking through 103.00. This pattern is likely to be echoed in Asian trading today but much of the market reaction to the Fed has already occurred and it will need more evidence of either stronger US data or more hawkish Fed comments to extend yesterday’s moves. US jobless claims today will take on more prominence in this respect in the absence of other major data releases with the exception of a likely gain in April new home sales.

The USD is set to consolidate its gains over the short term firmly underpinned by higher US bond yields. Funding currencies (JPY and CHF), yielding and commodity currencies (AUD, NZD and CAD ) look most vulnerable to a firm USD although almost all currencies have felt some of the pressure. The net result is that the USD index has reached its highest level in close to 3 years. Given that the rise in US yields may only mark the beginning of a deeper reversal the upside for the USD over coming months could be significant.

Fortunately for Asian currencies they have not been particularly sensitive to USD strength over recent months as domestic factors have taken on more prominence although the KRW and SGD have been particularly sensitive to JPY weakness. Nonetheless, Asian currencies are set to remain under pressure over the short term as concerns of a slowing in capital flows to the region may grow. Singapore’s better than expected Q1 GDP reading (1.8% QoQ) released this morning will do little to stem the pressure. Meanwhile comments by Korean officials on the impact on the country’s exports from a stronger JPY will keep the KRW pressured.

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