Dollar Bulls Tread Carefully Ahead of Bernanke Speech (page 2 of 2)

Collectively, the data supports the Bank of England's on-hold stance.

Over the past 2 weeks, UK economic data has been showing strong signs of improvements, suggesting to some that if this trend continues, 4.50 percent rates may be the bottom in the UK. Unless merger and acquisition activity continues to pick up however, the British pound's strength against the Euro and US dollar will probably remain limited.

Either way you cut it, the interest rate spread between Eurozone-UK rates and US-UK rates is narrowing against the pound's favor. In fact, the Fed's much expected rate hike later this month will turn long GBP/USD into a negative carry trade.

Japanese Yen

Although the Japanese Yen attempted to extend its gains against the dollar, the rally was short-lived as USD/JPY snapped back quickly after touching the 115.50 level. The rumor is that there may have been central bank buying at that level.

Hawkish comments from Bank of Japan member Mizuno helped the Japanese Yen recuperate some of the losses later on. Although, he warned that a premature rate hike was bad for the economy and that rates will probably remain near zero for the immediate future, the market chose to latch onto his view that it is "not too early for a monetary policy change."

Also helping the Yen was speculation that with US Senators visiting China, they may be pressured into loosening their currency again this week. We think that this is highly unlikely, but by the same token if USD/JPY continues to weaken, rumors of central bank bids and intervention will escalate.

There are only a limited number of ways for the Japanese government to manage tightening monetary policy with keeping the Yen weak and one of the easiest is to instill the fear that they may intervene to artificially weaken the currency either by words or actual actions.