Focus On Big Ben

The US dollar is somewhat firmer against most of the major and emerging market currencies as Federal Reserve Chairman Bernanke's testimony is awaited. The greenback remains largely within the ranges seen in recent days.

Sterling may be the exception. In response to the BOE minutes that showed the MPC vote unanimous and a better than expected employment report spurred a quick cent rally in the sterling that saw it rise above last week's Bernanke-inspired highs and stretch to almost $1.5250 before finding sellers.

The 9-0 verdict by the MPC says more about organizational behavior than monetary policy proper. It was the new governor's first meeting, having been in office barely a few days and, according to press reports, was having trouble with the proper underground stop. It would have simply been impolitic, if not rude, to have the dissenters at past meetings (Fisher and Miles) to do anything but what they did. It means nothing in terms of monetary policy signals. The next key is the August 7 quarterly inflation report.

The minutes would seem to confirm the expected shift toward forward guidance. The market's initial take away is that this reduce the chances of new gilt purchases and has seen UK bond yields retrace yesterday's decline, though the implied yield of the short sterling futures curve is soft through the end of next year.

The UK employment report is consistent with the recent string of data that is better than expected and consistent with a mild cyclical recovery. The claimant count fell 21.2k, more than twice the decline the market expected and the May count was revised to show a 16.2k instead of the 8.6k decline initially reported.

Bernanke's testimony before the House of Representatives today is the main focus. It overshadows the housing starts and permits. Bernanke's prepared remarks will be released at the same time as the data (8:30 am ET), which is 90 minutes before his testimony. Recently, it has been in the Q&A that the most market sensitive comments were made.

It seems unlikely that Bernanke's comments will be perceived as dovish as it was last week. Market positioning does not appear as extreme and, therefore, less vulnerable. It is unreasonable for Bernanke to go beyond his recent comments regarding the potential timing of the tapering.

Many observers have argued that the problem is that the Fed wants to draw a distinction between tapering and tightening which the market refuses to accept. We don't see it that way. Of course, investors know the difference. However, they also know that the talk of tapering is part of the exit strategy and that interest rates have likely bottomed before the Fed does anything. The markets are anticipatory in nature.

In addition, the FOMC minutes made clear that "almost half" of the participants, which is a category that includes voting and non-voting members, wanted to end QE by the end of the year. On the other hand, "many members", which is a category that includes only voters on the FOMC, wanted to see more job growth.

Bernanke leads the dovish contingent, which includes the Board of Governors and several regional presidents. Yet, investors are well aware that Bernanke most likely will not be Chairman next year. It is not clear that his words are binding for the next chairperson.

Bernanke's assessment of the economy will be scrutinized. Since the FOMC met, the data has been mixed. There has been a constructive jobs report, but other data have been mixed. Importantly, Q2 GDP estimates have been revised lower, with more talk of a sub-1% print. The FOMC meeting at the end of the month concludes a few hours after the first estimate of Q2 is reported on July 31.

Later today, after Bernanke's testimony is long done, the Beige Book will be released. The most important aspect to look for are signs that the backing up of interest rates is having a cooling effect on activity. Some officials, including Bernanke, seemed surprise by the magnitude of the increase in yields on the tapering signal. The Fed's reaction functions as more sensitive to surprises than to expected developments. The rise in long-term interest rates, if sustained, may impact the Fed's economic forecasts and feed back into policy.