Commentary: Fed in the Driver Seat as Markets Await Bernanke Testimony

Conflicting signals from top Fed officials continues to drive equity and FX markets this week, although now in the opposite direction.  The last week and half have been all about rumors of the Fed 'tapering off' its bond purchase program before the end of the year, stoked by comments by San Fransisco president Williams.  Williams, who earlier in the year had affirmed his support for continued asset purchases, suggested last week that he was open to a winding down of Fed's 85 billion dollar monthly bond purchase program as early as the end of the summer. Such talk had sent stocks lower and the greenback higher during Friday trading, capping a week long dollar rally that had resulted in fresh highs for USD/JPY. 


On the other side of the table, Chicago Fed president Charles Evans was keen to reassert teh dovish tone at the Fed in what may or may not have been an attempt to walk back the Williams' speech.  Evans acknowledged that the US economy is performing 'quite well,' relative to other advanced economies, Evans, arguably the most dovish FOMC member, stated that bond purchases were here to stay given subdue inflation and historically high unemployment. Evans comments have been met with fading of the dollar rally, indiscriminate of local fundamentals.  Despite a slowing economy and lower intra-day stock market, USD/MXN traded lower on the news, sliding to 12.27. 

Fed Chairman Ben Bernanke is also set to testify before Congress this week.  While his testimony is always a significant market event, this week's two day affair before House and Senate committees appears to be of particular significance, especially for the FX market.  Specifically, market participants will be looking for a clear direction from the central bank's chief as to the pace of any winding down of asset purchases.  Markets will be hoping for Bernanke to 'break the tie' between the conflicting statements put out by FOMC members recently.  Bernanke, whom  Evans called a "spectacular chairman," may calm markets by reaffirming the Fed's intention to continue its QE program well into 2014.  More likely, Bernanke is will stick the thresholds set by the Fed in late 2012 and stress the Fed's dual mandate of maximum employment in a context of price stability.  Asset bubbles, a major downside risk to cheap credit, are likely to be a theme, but 1.2 percent headline inflation and 7.5 percent unemployment leaves the door wide open for more stimulus.