Bernanke testimony may help the dollar higher

The Fed caught market participants off guard after announcing that rates will remain at exceptionally low levels until late 2014, extending the prior timeframe from mid-2013. The Fed also lowered its 2012 GDP forecast and noted that significant downside risks to the recovery remained.
The low rates pledge hit the dollar and sent it sharply lower against the majors. The pledge also helped gold move sharply higher while the low-rate pledge is also seen as very supportive for stocks.
Fed Chairman Ben Bernanke also hinted at activating another round of quantitative easing (QE), which would be the third since the 2008 global financial crisis started.
Despite the recent improvement in economic data from the US, it seems that the Fed wants to force the unemployment rate substantially lower than the current 8.5% rate, and they believe the best to do that is keep interest rates low for an extended period in order to help the recovery in the housing market, which in turn will push stock prices higher and in turn increase consumer confidence and spending and eventually lead to a reduction in the unemployed numbers.
Across the Atlantic, the European Central Bank (ECB) in late December loaned banks EUR 500 bln for three years at 1% and has pledged to continue buying sovereign bonds of Italy and Spain, which is another way of printing money.
Market analysts also expect the Bank of England to activate the next phase of its own QE in February in a vain attempt to kick-start the UK economy, which is saddled with huge debt and high deficits. The world’s third largest economy meanwhile – Japan – continues to remain in a slow growth environment and will also keep its interest rates at near to zero for an extended period of time. Tiny Switzerland has also pledged to print and sell unlimited amount of Swiss francs to defend the artificial level of 1.20 against the euro.
As long as the major central banks have pledged to maintain low interest rates and engage in QE measures in this or that form, market participants will rush to catch a fresh phase of central-bank driven euphoria, with equities rising in tandem with falling bond yields at a time when none of the structural debt challenges has been resolved in the Eurozone, the US or the UK.
The dollar weakness meanwhile in not expected to be sustained for long and there is a good chance for a market turn as early as on Thursday (Feb 2) when Bernanke will appear before the House Budget Committee. With Republicans dead against any round of QE3 which will further expand the Fed’s balance sheet through new bond purchases, there is a good chance that Bernanke will tone down his remarks and indicate that QE3 is not round the corner or active consideration. If so, then brace for a major rally in the US dollar and renewed attention to eurozone crisis, with Greece very close to default and Portugal following next.

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