Forex Market Outlook 8/26/11

Today is the day the markets have been waiting for some time, as Bernanke’s speech from the Jackson Hole Symposium is the most heavily-anticipated economic forecast in memory. We have obviously seem economic weakness and the Fed alone has been trying to tackle the issues that plague us as the fiscal side of the ledger has gone unattended due to a lack of leadership and political gridlock in Washington DC.

Speaking of political leadership, the Japanese Prime Minister Noda resigned last night after criticism of his handling of the natural disaster made him ineffectual. (Could you ever imagine a US politician doing this? Me neither!)

We received a glimpse of this dreary picture earlier this morning as GDP figures came in slightly lower than expected, showing 1% growth vs. the expected 1.1%. Personal consumption figures came in higher than expected, showing an increase of .4% vs. the expected .2%. This all adds up to slowing growth, though this is the type of report that brings relief as it could have been a lot worse.

Earlier this morning, the UK reported GDP figures that came in as expected, showing quarterly growth of .2% and a YoY figure of .7%. This also is declining growth which has the BOE policy-makers concerned and may produce some further monetary easing if conditions get worse. However, further easing could push inflation higher than the already high 4.4%, which is more than twice the Central bank’s target rate.

But back to Bernanke, what will he say today? How will the markets react? With the insane amount of volatility we have experienced of late, the response is likely to be knee-jerk and should produce wide swings.

There are essentially two schools of thought on this matter: he will either hint at further easing, or he will not. At this point, no one is expecting him to launch “QE3” though he could put forth that possibility.

If he chooses the first option and sets the table for further easing, he could do so by laying out the potential policy tools he could use. Whether its further bond buying, buying mortgages, targeting the longer duration bonds or some other measure the market reaction would likely be to sell the Dollar and jump into just about anything else.

But from a longer-term perspective, this could be offset by the problems we are seeing in the Euro zone which have gone unnoticed as the focus has been on today’s speech. Greek 2-year yields are at all-time highs and it is unclear if the vote to expand the EFSF will pass in its current form. The German stock index (DAX) is down nearly 20% this month alone!

With the specter of further easing, commodities and stocks are likely to be the beneficiary and the impact to the real economy could be little at best. This could also induce higher inflation, which would choke economic activity as well.

If Bernanke says nothing today that is new from a policy perspective, then the markets are likely to be disappointed and we could see some Dollar strength right out of the gate. Though the long-term impact is uncertain, I believe that stocks (particularly ones with high dividends) will be in favor as there really is nowhere else to put your money. The initial flight to safety trade could go on straight through the Euro vote on the EFSF as that would be the major risk in the marketplace.

Next week the politicians will be back and we’re expected to hear from Obama about his jobs plan, which was apparently too involved to reveal prior to his vacation so the country has to wait another week. Expect to also hear the rhetoric for increased government spending and not reduction to take place, as the stalemate and gridlock hopefully don’t drive us off the proverbial economic cliff.

So what will I be in prior to this speech? Nothing. As a trader, I prefer no to try to guess what is going to happen but rather to take a wait and see approach and look for potential low risk opportunities that may be created by volatility. So trade cautiously, as volatility can be your friend but can also be your worst enemy if you get stuck in the wrong trade!

Tags:  markets leadership japanese prime minister disaster ineffectual expected conditions