Dollar Collapses as Bernanke Talks of a Pause in Rates (page 1 of 2)

US Dollar

On what was suppose to be a quiet day with little data, the US dollar took another beating as Federal Reserve Chairman Ben Bernanke raised the possibility of a pause in the FOMC's tightening cycle. This is as dovish as we could expect from the central bank at a time when inflationary pressures are indeed building and recent economic reports have been showing signs of growth.

Furthermore, the Fed is acknowledging these upside risks by saying that even "if its objectives are not entirely balanced," they may decide to "take no action at one or more meetings," which is their way of saying that they may not be phased by the recent reports. It is quite clear that the cards are stacking higher and higher against the dollar's favor and Bernanke's latest comments may indeed be the straw that breaks the camel's back.

This is in line with our expectations for interest rates to be capped at 5 to 5.25 percent. We are already above the psychologically and technically important 1.25 level, which means that there is room for more strength. The persistence of the Fed has been the main factor that has kept dollar weakness against the Euro relatively tame compared to its weakness against the Yen, but now that they have for the first time introduced the possibility of a pause, we could see the support beams give way.

Dollar bulls will now have to contend with the world calling for more strength in Asian currencies, reserve diversification, geopolitical risks and a possible end to the Fed's tightening cycle. Such grave risks could scare many bulls out of the market even if we get a strong GDP report tomorrow. The market has already shrugged off many pieces of good data so we would not be surprised if it did the same for GDP, especially since it is commonly seen as a lagging indicator.

We have been saying all week that the latest shift should not be taken lightly since it is a result of many different yet serious fundamental factors. Next week, we will have a lot more data to contend with including non-farm payrolls and judging from Bernanke's comments, the Fed will be watching the reports very closely to determine when this potential pause may come.

Most analysts still believe that we will see a May rate hike, but the June interest rate hike is much more up in the air at this point. The only saving grace for the dollar against the Euro will probably come from the ECB. If the central bank becomes concerned about Euro strength and begins to talk down the Euro or delay further the need for continued rate hikes on their part, we could see a much needed retracement.

Euro

The Euro skyrocketed today on comments from Bernanke, marking the fifth consecutive day of strength for the currency against the US dollar. Eurozone economic data continues to come in strongly with German unemployment falling by a more than expected 40k in the month of April.

This brought the unemployment rate down to 11.3 percent from 11.4 percent. Italian business confidence also picked up, rising from 94.5 to 96.1. The strength of data has prompted some central bankers to remain hawkish with ECB member Garganas saying that interest rates remain very low and "we need to expect more rate increases" in the future. Admittedly rates are extremely low and do need to be increased, but the question lies in he timing of the increase. With the EUR/USD trading above 1.25, the currency is tightening the region's economy without the central bank's help.

The 500 pip rise over the past month will certainly have an impact on exports, which will filter into weaker economic reports for the month of May and June if the currency remains at current levels.