UBS Economists continue to forecast the first hike in the funds rate in June 2010. The Fed's balance sheet and monetary base will likely start shrinking before the first rate hike (in H1 10), although the levels will likely remain historically high for a while-appropriately so, in their view, given the likely weak recovery initially and the downward pressure on inflation from a high level of slack. Please review the FX weekly perspectives report posted in the free members area, where FX forcasts show USD to strengthen in Q4 through H1 2010.

The expectation for Fed tightening soared to over 120bp back in early June, making it the highest among the G10 central banks. Expectations have come down since then though the Fed still remains on the higher end of the spectrum. It remains to be seen if expectations are ratcheted down further following the conclusion of Bernanke's testimony.

The dollar weakened ahead of Fed Chairman Bernanke's testimony on the Fed's semi-annual monetary policy report. But concerns on a troubled lender and Bernanke's testimony helped the dollar regain some losses.

Bernanke was subdued on the economic outlook, though he did note demand and production have shown tentative signs of stabilization. He made it clear the Fed is in no rush to tighten policy but that the Fed has the ability to do so. Please review this reuters article for details:

http://www.reuters.com/article/marketsNews/idUSN2135729420090721

We are still positive on the US dollar on the likelihood of greater risk aversion on a 3m time horizon.

ECB Governing Council member Nowotny said the ECB has a clear exit strategy and could withdraw liquidity quickly if needed. But Nowotny also said now is not the time to act though he sees Euro area growth returning in 2010.
We continue to see the euro struggling in the immediate future and maintain our 3m EURUSD forecast of 1.30.

The RBA minutes showed the bank maintained an easing bias while sounding increasingly optimistic on the growth front, as the minutes stated that, "Early and substantial easing of both monetary and fiscal policy had been effective in supporting demand, which, if anything, had been more resilient than expected."

UBS economists continue to expect the RBA to hold rates, with stronger economic data in the past few months weighed against clear slowing in upstream price. Q2's CPI release should show headline inflation undershooting the RBA's 2-3% target for the first time since Q307, though they expect core inflation to be a bit more 'sticky'.
AUD will likely remain supported by risk appetite this week, but on a 3m horizon we look for losses on the back of higher risk aversion.

The head of the UK's Debt Management Office Stheeman said that international investors have maintained a healthy appetite for gilts and said that while a future ratings downgrade could affect yields, it would not seriously concern overseas investors. A succession of downgrades, however, would be a different matter.

In separate comments, BoE Deputy Governor Bean said the 20% fall in sterling since the start of the crisis should help an export-led recovery and officials would not welcome a strong recovery in sterling. He also said the BoE would try to keep interest rates low for as short as possible as BoE agents are saying the economy has probably bottomed.

The BoC was unchanged as expected. They did not cut the official rate and did not implement any quantitative or credit easing. There was a shift in the language on recent CAD strength, though, as the BoC dropped the previous phrase, "If the unprecedentedly rapid rise in the Canadian dollar," in favor of, "However, the higher Canadian dollar, as well as ongoing restructuring in key industrial sectors, is significantly moderating the pace of overall growth."

The CAD benefited from the shift in commentary on recent CAD strength but USDCAD eventually finished higher on the back of renewed USD buying. With investor sentiment fragile, we maintain our 1m USDCAD forecast at 1.15.

Tags: FED