Traders Seek Direction from Bernanke, GDP on Friday

The U.S. Dollar fell today on speculation thatFed Chairman Bernanke, during his speech on Friday before the central banker’sconference in Jackson Hole, Wyoming,will hint that the Federal Reserve could take further action to prop up the U.S.economy.

The U.S. Dollar fell today on speculation that Fed ChairmanBernanke, during his speech on Friday before the central banker’s conference inJackson Hole, Wyoming,will hint that the Federal Reserve could take further action to prop up the U.S.economy.

Early gains in the U.S. equity markets helpedhigher-yielding currencies, including the Canadian, Australian and New ZealandDollars. The weak outlook for the economy boosted interest in the Euro, BritishPound, Swiss Franc and Japanese Yen.

The Dollar opened lower on Thursday and was driven furtherdown by a slightly better than expected U.S. Weekly Initial Claims report. Thisweakness lasted until shortly after the equity markets opened. The Forex marketsbegan to weaken against the Dollar once equity markets topped and began a slowdownward slide.

At first it appeared it was going to be a “risk-on” session,but sentiment shifted as investors decided there wasn’t enough bullish news tomaintain the rally in the stock market. Another reason for the mid-morningbreak was position squaring ahead of tomorrow’s key speech by Bernanke.

Earlier in the week I questioned whether the Fed was out ofbullets to combat the economic weakness threatening the U.S. economy. Having watched two dismal U.S. housing reportsthis week, I am now anxiously awaiting Federal Reserve Chairman Bernanke’soutlook for the economy, his explanation for the Fed’s recent decision to buyTreasury Bonds, and perhaps what the Fed could possibly have left in itstoolbox to combat the threat of a double-dip recession.

No one is certain what Mr. Bernanke will talk about onFriday at the annual Fed gathering of central bankers in Jackson Hole, Wyoming.There is plenty to talk about since the economy has changed so much since thelast Fed meeting earlier in the month. Based on his recent public statements,the Fed Chairman is likely to reiterate his concerns about persistently highunemployment and the extremely low inflation rate that is threatening to drivethe economy into a deflationary scenario.

Because of the current fragile state of the economy, Mr.Bernanke’s comments are likely to move the equity and debt marketsubstantially. Since he doesn’t have the evidence to paint a rosy outlook, heis going to have to stay the course by reiterating that the economy remains“uncertain” and cooling off or he may reveal a bleaker outlook.

There is no question based on current activity in theTreasury and equity markets that the Fed is moving the market. Its recentdecision to buy Treasury Bonds, for example, has triggered a huge rally in thismarket prompting some to call it a “bubble”. Equity markets have weakened sincethe last Federal Open Market Committee meeting because its move to buy Treasuryssent a message that perhaps the economy was weaker than previously thought.

I believe Bernanke has to speak about the economy withclarity and conviction. This may help to bring relief to those investorssuffering from a “crisis in conference”. Bernanke also has to provide a littlecolor about what the Fed is considering to do should the economic situationcontinue to worsen. One thing that he may shed some light on is whether the Fedis considering lowering the interest rate on reserve deposits banks have withthe Fed. This may encourage banks to open up their lending windows a little.

Since this will be a question and answer session withBernanke and he is used to a professorial speaking style, there is thepossibility that reporters will ask tough questions that he has difficultyanswering. This could contribute to the already expected high volatility.

In addition to the Fed Chairman’s speech, U.S. 2nd Quarter GDP – SecondEstimate will be watch closely by investors. Since this report will be releasedbefore Bernanke talks, its interpretation will set the tone for the day unlessBernanke says something extremely optimistic about the economy. Economists areestimating that GDP will show growth of 1.3% versus the previous estimate of2.4%. The worst case scenario will be negative growth. This would send theDollar and T-Bonds soaring and equity markets plunging in heavyflight-to-safety buying.