Euro Attempts to Gain on Hot CPI, Dovish Rhetoric from Fed Chairman Bernanke

[B]Talking Points
• Japanese Yen: Headline inflation rises at fastest pace in nearly a year
• Australian Dollar: Exports lead current account deficit to narrow in Q3
• Euro: Euro-zone CPI flash estimates hit 6-year high of 3.0%
• Swiss Franc: Stronger-than-expected CPI, GDP raise SNB hike prospects
• US Dollar: Little reaction to Bernanke comments, awaiting Personal Income/Spending[/B]

For much of the Asian trading session, the greenback went very little changed despite speculation that commentary by Fed Chairman Ben Bernanke last night signaled a rate cut by the central bank next month. Bernanke said that incoming data “will help to shape the Committee’s outlook for the economy,” but centered the Fed’s focus on instability in the financial markets as they have “partially reversed the improvement that occurred in September and October.” However, the release of European inflation data eventually helped to nudge EUR/USD up for a test of 1.4785.

Looking at the European economic data, the annualized Euro-zone inflation flash estimate for November surged to 3.0 percent from 2.6 percent. If this figure is confirmed on December 14th, it will mark the fastest pace of CPI growth since May 2001 and is well above the European Central Bank’s 2.0 percent inflation ceiling. Meanwhile, confidence amongst consumers and the services sector both fell back in November, as rocketing energy and food prices take their toll. On the other hand, the Q3 GDP figures for the Euro region reflected a resilient economy, with the annualized rate of expansion improving to 2.9 percent as exports rocketed higher despite the rapid appreciation of the area’s currency. The combination of red-hot inflation and sturdy export growth countered by instability in the financial markets and its potential negative impact on the economy in coming months puts the ECB in a very tough position. If ECB President Trichet does not tighten monetary policy or at least give the impression that a rate hike is on the way, he may be viewed as abandoning his price stability mandate.

Likewise, similar results were seen in Switzerland as CPI rose 1.8 percent in November from last year - the sharpest gain in more than six years - as a result of mounting costs for heating oil and energy. While this is below the Swiss National Bank’s 2.0 percent inflation ceiling, the data makes the central bank more likely to raise rates 25bp to 3.00 percent at their next policy meeting on December 13, as SNB President Jean-Pierre Roth said recently that their inflation forecast may “underestimate price pressures” caused by the weakness of the Swiss franc against the Euro, which makes imports from the Euro-zone more expensive.

Overall, today’s data creates an increasingly dour picture for the greenback, as it appears that both the ECB and SNB will seriously consider raising rates in December while the markets continue to aggressively price in a rate cut by the Fed. While the potential for softer growth in coming months in Europe and tight credit markets conditions clearly create substantial risks and confusion for both the ECB and SNB, their own policy mandates focus more on price stability than for the Fed. Given these conditions, it seems that there is little hope for a substantial US dollar rebound over the next few months. However, traders should keep one thing in the back of their minds: what if the Fed does the “unexpected” and leaves rates steady in December? Though the result could be disastrous for equity markets, dollar bulls may finally have the opportunity to regain control. Is there any middle ground? Bernanke & Co. could consider simply cutting the discount rate to facilitate short-term interbank lending but leave the federal funds rate unchanged. In this case, US stock markets may still pull back, but not as severely as if there was no policy change at all, while the greenback could stand to gain on the pure surprise alone. Unfortunately, the mixed signals that various FOMC members have been giving in their speeches leaves the result of the upcoming policy meeting in December a wait-and-see scenario for the dollar.