The benchmark money-market rate reached a three-year high after the central bank drained cash from the banking system to cool economic growth. The renminbi climbed 0.57 percent in the past five days, a fifth weekly gain, and reached the strongest level since China unified official and market exchange rates at the end of 1993. The yuan will continue to appreciate, advancing 6 percent next year, said David Cohen, an economist at Action Economics Ltd. in Singapore.

Policy makers “recognize the usefulness of a stronger currency in curbing inflation,” said Cohen. “The yuan, like other Asian currencies, has very strong fundamentals and the country has a very large current-account surplus.”

The yuan climbed 0.17 percent to 6.5897 per dollar as of 4:30 p.m. in Shanghai, earlier touching a high of 6.5896, according to the China Foreign Exchange Trade System. Twelve- month non-deliverable forwards were little changed at 6.4608, reflecting bets the currency will gain 2 percent in a year.

The People’s Bank of China set the reference rate higher for the ninth day, at 6.6227 per dollar today compared with 6.6229 yesterday. The yuan is allowed to trade by up to 0.5 percent either side of the so-called central parity rate. The U.S. Dollar Index, a gauge of the greenback’s strength, retreated for the seventh day.

Hu’s Visit
The main appreciation of the yuan will likely happen in the first quarter, with Hu Jintao’s state visit to Washington next month, said Craig Chan, an Asia foreign-exchange strategist at Nomura Singapore Ltd. on Dec. 16. The House of Representatives passed legislation in September letting U.S. companies petition for duties on Chinese imports to compensate for the effect of a weak yuan.

The renminbi will be the top performer among the so-called BRIC nations currencies in the coming year, according to analyst surveys by Bloomberg. China’s currency will strengthen 4.9 percent to 6.28 by the end of 2011, according to the median estimate of 19 analysts in a Bloomberg survey. That’s over double the 2 percent gain projected by 12-month non-deliverable forwards.

Analysts predict Brazil’s real will weaken 2.4 percent, Russia’s ruble will appreciate 0.6 percent and India’s rupee will rise 3.7 percent.

Offshore yuan forwards rose 0.34 percent to 6.5800 per dollar in Hong Kong. Twelve-month deliverable forwards in the city were at 6.5760 today, compared with 6.5725 yesterday.

Zhou Pledge
China’s consumer prices climbed 5.1 percent from a year earlier in November, the biggest gain in 28 months, the statistics bureau said on Dec. 11. The yuan is a denomination of China’s currency, the renminbi.

Central bank Governor Zhou Xiaochuan pledged in his New Year message to tackle inflation, saying the nation had consolidated its recovery in 2010. Zhou reaffirmed a shift to a “prudent” monetary policy in 2011 from the “moderately loose” stance that countered the financial crisis.

The seven-day repurchase rate, which measures lending costs between banks, advanced seven basis points to 6.34 percent, the highest level since October 2007, according to a daily fixing published at 11 a.m. by the National Interbank Funding Center.

The yield on the 3.67 percent government bond due October 2020 was unchanged at 3.88 percent, according to data compiled by Bloomberg. One-year interest-rate swaps, or the fixed cost needed to receive the floating seven-day repurchase rate, slipped four basis points to 3.17 percent.

Lenders are holding onto funds after policy makers raised banks reserve requirements for the third time in five weeks to curb inflation. The central bank on Dec. 25 also lifted the benchmark lending and deposit rates by 25 basis points, the second increase this quarter.

Policy makers are likely to boost lending and deposit rates by about 2 percentage points more next year, said Tao Dong, chief economist for Asia excluding Japan at Credit Suisse Group AG. in Hong Kong Dec. 22.

Turkiye Is Bankasi AS and Turkiye Garanti Bankasi, the two largest listed lender in Turkey, the plan to give the local bond market as the central bank reduces interest rates. Based in Istanbul Akbank TAS, the third largest, and 20 percent owned by Citigroup Inc., one billion lire (658,000,000 US Dollar) of 178-day licenses sold Dec. 13, the first offering in the fixed income its kind by a turkish retail bank.

Yields on two-year government bonds fell to 7.25 percent yesterday, falling below the bond rates in India for the first time in the tightest level since at least 2006 on the Polish debt, according to data compiled by Bloomberg. turkish yields fell, inflation fell to 7.3 percent in November, compared to 70 percent a decade ago.

“There is more room for yields will fall, as investors bet that inflation” comes out very low in February and March, “said okte Isik, a trader Finans Invest in Istanbul. “Bonds issued by banks are all linked to this environment of low interest rates. Others will follow, because it is a way of financing at low cost.”

Sponsors revealed three days ago, which applied to regulators to sell up to 3 billion pounds in local currency bonds with different maturities. Isbank applied last week to spend up to 5 billion pounds of debt.

Rarity
Akbank bonds were at a 7.28 percent return, compared with 6.5 percent for June 2011 Turkish lira bonds, data compiled by Bloomberg prices show. Demand for debt sold by Turkish banks will be enhanced by their rarity value, “said Simon Quijano-Evans, chief economist for emerging Europe, Middle East and Africa at Credit Agricole SA Chevreux in Vienna.

“Investors are willing to offer everything that a pickup in yield to buy bonds,” Quijano-Evans said.

Since Prime Minister Recep Tayyip Erdogan took power in 2003, the gross domestic product at constant prices grew by 34 percent, including contractions in 2008 and 2009, according to the National Institute of Statistics. The expansion requires banks including UniCredit SpA of Italy, National Bank of Greece SA, London-based HSBC Holdings Plc and France’s BNP Paribas SA, the investment banking sector.

New rules
The financial system of the country’s regulatory body for the industry has given permission bond sale will start on 1 October Lira, the publication of a set of rules on its website that the banks to issue debt up to a limit of a formula takes into account the base has authorized its deposits, shares, goods and capital. may be the maximum output of 51 billion lire set, extended, Tevfik Bilgin said the head regulator on December 8.

Akbank and other Turkish banks receiving funds from the bond market, after Moody’s Investors Service, Fitch Ratings and the year the credit ratings Turkey last year Standard & Poor’s. Fitch raised its outlook on its BB + rating, the highest non-investment grade, which uses a “positive” from “stable” on Nov. 24, citing the strength of the Turkish economy and the improvement of public finances.

Rate cut
The central bank reduced the benchmark lending rate by 50 basis points to a record level of 6.5 per cent yesterday, after it has been fixed for a year to stem capital inflows from abroad to expand the deficit currents. The bank gave no further information on rates.

An increase in Turkey, investment grade in the general election next year, set for June, also in a decline in bond yields, “said G’rol Ozer, head of fixed income trading and the Istanbul-based Deniz Bank AS. Moody’s and S & P rates Turkey, two levels below investment grade.

“We think that Turkey can be updated by the end of next year,” Ozer said. “It ‘s difficult to define a plan for bond yields to predict now.” Yields on government securities of two years, is likely to fall as low as 6 percent to slow inflation to 5.5 percent, the estimate of the Central Bank by the end of next year, he said.

Mortgages Lag
Bank lending rose 13.7 per cent this year and surpassing the expansion of the sector, and in 2011 will be a year to showcase the industry, “said Bilgin November 12. The amount of outstanding mortgage debt corresponds to Turkey 5 percent of GDP, according to the Central Bank. This compares with the EU average of 49.8 percent from 2008, compiled the latest figures of the European Mortgage Federation.

holdings of foreign investors turkish domestic debt accounted for 12.3 percent of the total exhibition in October from 8.9 percent in January, the data on the website of the Ministry of Finance.

denominated domestic investors are likely to be the pillar of the corporate bond market in pounds, which have less liquid market for the turkish government bonds and not so much economically, said Kieran Curtis, managing more than 2,000,000,000 US Dollar in emerging market bonds contribute Aviva Investors in London.

“The results do not seem that attractive, liquidity is not that fantastic and the spreads are not going well,” said Curtis, adding that its funds “light” is underweight bonds turkish, because “real yields are not as interesting and there are other interesting coins to invest in ”

The government is selling bonds for less than a percentage of debt maturing in 2011 than this year, with the rate decreases to 88 percent or 135 billion lire, from 90 percent in 2010, said Minister of Finance October 28.

“The Treasury should not pull up a little more space for private sector bonds,” Quijano-Evans said. “Once, in the long term, bonds, banks can offer to get the prize being a bit ‘more attractive than the national debt.”

US Dollar Extends its Worst Trend in Four Months after Retail Sales Contracts
A fourth consecutive down day for the US dollar (on a trade weighted basis) defines the worst trend the benchmark has suffered since September. The currency’s bearish bearings have been set for going on four weeks now; but through this unfavorable drift, there has been a clear lack of conviction – often termed momentum. Without a decisive trend in underlying sentiment or a clear shift in Fed interest rate expectations, it seems the greenback is anchored to well-tracked ranges. The best representation of the underlying dollar’s lack of strength and volatility is best reflected with EURUSD. A modest gradient on a very consistent, rising trend channel has contained price action but not with highly precise levels of support and resistance. Though heading into the final trading day of the week, there are more reliable short-term levels to watch such as 1.4450 as a floor and a 1.4560-ceiling. Both the yen and Swiss franc-based majors offer similar patterns; but it is the commodity bloc that highlights the importance of risk appetite among FX traders. With an exaggerated yield differential heightening its appeal, AUDUSD is just below a 14-month high. And, whether it holds water or not, both the NZDUSD and USDCAD have ridden the Aussie’s coattails to meaningful levels of dollar-support as well.

With this eerily-quiet backdrop in mind, we must remember that most fundamental drivers for the US dollar at this point are filtered through speculation surrounding either underlying investor sentiment or the currency’s position on the risk spectrum. This is largely why some historically market-moving indicators have fallen flat with volatility while seemingly innocuous news can set things in motion. Today’s data would be good for only a modest adjustment to the health of the US economy and market-wide risk appetite. The top release was the December retail sales report from the Census Bureau. Against an official consensus forecast of a minor increase in consumer spending, the report showed a 0.3 percent contraction. No matter how the data was sliced (looking at individual sectors, cutting out vehicle sales or gas), the data was moderately dovish. However, there are arguments that this data could have been distorted by seasonal adjustments or due to the blizzard that struck the Northeastern United States. What’s more, sentiment was modestly improved by a revision to November’s readings (upgraded to a 1.8 percent increase from 1.3 percent). Regardless, this data maintains, the recovery for the US will be uneven and tepid as the economy works through high unemployment, stunted lending, low business investment and many other factors.

In the bigger scheme of things, a stable economic footing is essential for the eventual return of hawkish monetary policy. However, policy officials do not have the luxury to simply wait for the recovery to fully setup and all other factors to fall in place. Should inflation return with force, the Fed could be pushed into a tightening regime to prevent a much more complicated economic scenario from unfolding. The Import Price Index released today showed no monthly change in imported inflation; but the annual rate accelerated to a 16-month high 8.6 percent. To truly unnerve the central bank through, Chairman Ben Bernanke and his fellow board members have to see a distinct threat of medium-term consumer price pressures holding above the their target. The consensus for Friday’s December CPI reading already puts the reading above the 2.0 percent objective with a forecast for a 2.8 percent annual reading. A reading this high or greater (especially should it be backed by a big increase in the annualized core figure) will certainly weigh on rate speculation. But will it be pressing enough to unsettle the dollar?

Related: Discuss the US Dollar in the DailyFX Forum, Watch the CPI release and its impact on the USD Live!
Euro: ECB Casts a Dovish Forecast, Warns Market about Greece’s Influence on Region
Heading into Thursday’s session, no other event or indicator held as much market-moving potential as the European Central Bank’s (ECB) rate decision. However, in recent months, the announcement has taken on a sense of formality. As expected, the authority announced that it would leave the benchmark lending rate unchanged at 1.00 percent for an eight consecutive meeting. Furthermore, the projections for ending the bank’s larger stimulus efforts (like its six-month loans) was kept on pace. Yet, there was better illumination on the future through President Trichet’s public address. On the topic of growth, the central banker said the outlook had improved slightly, though he also mentioned that risks had increased. The topic du jour was the threat that Greece may cause the broader European community. German Prime Minister Merkel said in a separate venue that the nation’s troubles posed a threat to the euro; but Trichet said no government will receive special treatment when it came to rules like deficit limits.

Perhaps the most memorable quote from this morning’s Q&A though was the President’s effort to definitively set medium-term inflation as his compass for rate decisions. It just so happens that tomorrow’s docket brings with it the December readings of CPI for the Euro Zone. Indeed, if the bank is expressly committed to maintaining annual inflation near the 2 percent target through the coming three-to-twelve months, the group may be able to defer any touch decisions for at least a few months. The consensus calls for an increase in the annual rate from 0.5 to 0.9 percent – well below the water market and moving at a reserved pace. However, it is mundane forecasts that leverages surprises.

Related: Discuss the euro in the DailyFX Forum
Australian Dollar Rallies as Employment Data Fortifies Rate Expectations
The Australian dollar was the strongest major for the day Thursday thanks to an employment reading that had dispelled building fears that the central bank would be dissuaded from a fourth consecutive rate hike come February 1st. According to the Australian Bureau of Statistics, firms hired a net 35,200 Aussies – the fourth consecutive monthly increase in payrolls and arguably the strongest pace of hiring in years. What’s more, the unemployment rate unexpectedly fell to 5.5 percent. In turn, the market is now pricing in a near 75 percent probability that the RBA will hike at its next meeting. However, maintaining such a consistent pace (the policy body has never hiked at four consecutive meetings) without looking for previous moves- impact would be exceptionally aggressive. Given recent hikes, Fitch has predicted bad debt loan losses will jump in 2010.

- Dollar enjoys safe haven status, loses interest rate potential
- Has the dollar’s late-week correction altered the bullish revival?

Dollar bulls seem to enjoy a bit of schadenfreude. While the financial markets are under strain and the risk of a full blown crisis is at its peak, the benchmark currency shines for its safe haven properties. Without this background preoccupation, the greenback seems relatively lackluster compared to its primary counterparts. With a benchmark lending rate just above zero, a growth forecast that calls for a significant cooling of pace in the second half of this year, an overwhelming debt load and the nagging concern that the world may one day trade out their dollars for some other reserve currency; the currency will struggle to compete on an even playing field. However, markets are dynamic and speculative interest is an indelible component of its normal functioning. For this reason, the basic assumptions of relative growth and yield are only impressive or disappointing so far as investors are excessively greedy or risk adverse. Considering the fundamental waves that are seen over the coming week, this particular angle promises to define the dollar’s next move.
At the very forefront of the fundamental trader’s mind is what will happen over the weekend. Concerns over Greece contributed to the greenbacks gains last week and it also set the benchmark to its sharp correction. Therefore, it is reasonable to believe the same source of activity will maintain its continue to define volatility ” at least through the near-term future. This event is at the brink of another critical stage. No longer is there doubt that the nation is in trouble. Now, they are holding out their hats and asking for assistance. What does this mean to the dollar trader? If confidence or the EU fails Greece, this country will very likely default, exit the monetary union or find some other unique and painful solution. This will almost certainly hurt the euro in the eyes of investors; which will send capital fleeing to its primary counterpart (the US dollar). Wading deeper into this scenario, if Greece falters; it would likely send credit and financial market ripples across the world. Considering the current, over-extended level of most growth-related assets, such a catalyst could have dramatic consequences. That being the case, the traditional harbor for rough seas ” the greenback ” will open to all.

Another interesting event over the off-market days is the summit in Washington DC. The G-7, G-20, IMF and World Bank are scheduled to meet and discuss the economy, financial health and the conversation is likely to shift to Greece at one point or another. Given the highly dynamic nature of the markets at this point, it would not be unusual to see a promise relating to international policy. However, domestically, dollar traders will be looking for confirmation to speculation that the Federal Reserve is planning on selling off the assets on its bloated balance sheet. Such a move would be a big step in the hawkish direction and pass another milestone to the inevitable rate hike.

And, to round the risky week out, we have a round of major scheduled event risk. The FOMC rate decision won’t offer any changed to the Fed Funds rate; but we will be kept busy watching the discount rate, possible changes to non-standard policy and closely interpreting the language of the statement for timing cues. Offering far better opportunity for clear price action is the advanced reading of the 1Q GDP figure. Due Friday, this reading is actually expected to downgrade the economy’s robust pace of recovery as the stimulus fuel runs thin and the market starts to take over. Though expected, such a downshift could significantly cool interest rate speculation.

Analysis
While the EURUSD can be a misleading gauge of strength for the euro (as it has recently been more responsive to the US dollar), the benchmark pair currently presents an accurate portrayal of the single currency, its main uptrend long broken by dollar strength, now struggling to hold onto another such rising channel.

Key Euro Drivers
Taking a quick glance across the majors, it becomes apparent that nearly every one of the euro crosses is sitting at the bottom of a broad range. It is make or break time for the unloved currency; and the catalyst for its ultimate bearing will likely fall to one of four pressing issues:
1. The financial stability of the European Community (particularly of the PIGS: Portugal, Greece, Ireland/Italy, Spain), referred to often in these pages as sovereign debt threat
2. US dollar performance either improved fundamentals or
3. US dollar performance as a safe haven should risk appetite retreat
4. A meaningful change in interest rate forecasts

The US Dollar
The primary driver of the euro is the interplay of risk appetite and the dollar, points 2 and 3. Because the EUR/USD pair by itself is about 30% of all forex trade, these two currencies tend to push each other in opposite directions. Should risk appetite rally or plummet, expect EURUSD to follow suit. See our US Dollar Weekly Outlook for the key events and forces to watch for measuring the dollar’s outlook, and thus so too the euro’s.

Sovereign Debt Threat
The next major concern is the threat of further sovereign debt downgrade or outright default. This has loomed large over the euro since Dubai World’s problems drew attention to sovereign credit risk and got the various rating agencies attention and alerted them not to be caught unawares again.?? The failing financial health of Greece, which clearly has lacked the political will for real financial reform, has undermined confidence in the euro and in prospects for the growth, stimulus reduction, and rate increases needed to support the euro.

The downside of developing a single market among different nations has been laid bare through the recent economic difficulties. In sum, fundamentally different economies have different needs and priorities While German and France have been quick to recover and can benefit from a stronger euro as the group’s most prosperous members, others have struggled to recover, particularly as a strengthening euro hits their more easily replaceable, less competitive exports, harder.

Most crucially, each member government gives up lot of flexibility to combat financial downturns, like its right to individually adjust monetary policy, manipulate its currency, increase its debt load and more, that have given the US, UK, and others crucial tools to adapt to unfavorable conditions. It is unclear how many of the weaker members will meet the goals policy makers have set out and EU officials have warned no exceptions will be made. Currently the balance of power in setting policy is clearly with the wealthier Northern countries.

The current picture offers no clear solution. The Greek PM reiterated that Greece was not seeking any IMF bailout or planning to exit the Euro Zone, but then again he provided practically no details on how the country would finance its budget or drastically cut its debt-to-GDP ratio in order to meet the EU’s Maastrict criteria. The ECB published its opinion on Greek debt restructuring law, stating that the move could hinder the flow of credit and hurt markets. On Friday, the ECB’s Trichet talked tough, declaring that the country has a “major debt problem” and that no government should expect special treatment,” specifically mentioning both the Greek and Irish situations. His words pushed the 10-year Greek/Bund spread beyond the 280bps level. Spreads among other peripheral European debt have widened noticeably as well: the Ireland/Bund 10-year spread was at +162bps, while the Portugal spread was at over +95 bps, at its widest level since last April. In short, it’s getting more expensive for these countries to borrow, creating a vicious downward spiral.

While all involved deny it, there is a real possibility that EU membership may eventually prove too expensive for the weaker economies to afford.

Despite the ECB’s decision this past week to hold its benchmark lending rate unchanged and President Trichet’s suggestion that there was no threat of medium-term inflation, the market is pricing in 89 basis points worth of hikes through the next 12 months, which puts the euro ahead of its US, UK, Swiss and Canadian counterparts.

weaker economic data also weighed on the euro. Even though Euro-zone consumer prices increased modestly, the region’s trade surplus fell from EUR 6.6 billion to EUR 4.8 billion. Although the strength of the euro did not hurt trade in Germany, it negatively affected exports in Ireland, Greece and Spain.

Events
As noted above, potentially market moving Eurozone economic releases including the German ZEW survey, the advance PMI releases and German producer prices.

On the other hand, when risk aversion rises; the euro is often the standard bearer for the flight to safety that sends the greenback rallying. We are currently at the cusp of a dramatic shift in underlying sentiment. For much of this year (from Approximately February up until the start of December), sentiment has steadily advanced as investors have put their capital back into the speculative market space. However, the advance that has resulted has moved well beyond the realistic expectations of growth and expected yield growth. Eventually one has to correct to the other; and fundamental economics measure changes in months and quarters. Yet, when positioning for such a significant shift; it is important to confirm that such a seismic change is underway. If a EURUSD break is indeed underway; equities, commodities, fixed income and most other risk-attuned asset classes will all fall into line.

Moving beyond the gravitational pull of the US dollar, the euro is making significant headway on its own. Among the medium-term trends to keep track of for the euro is the slow shift in monetary policy and the pace of the region’s recovery as compared to its peers. The European Central Bank held its benchmark lending rate unchanged at its December 3rd meeting; but the event nonetheless developed a hawkish bias when President Jean-Claude Trichet said unlimited 12 month loans would expire this month and 6-month loans at the end of the first quarter. Officials have said that this should not be considered a sign that the bank is preparing to raise rates; but this is an inevitability given the path the bank is now on. As for growth, there Euro Zone is the collection of member economy’s that are recovering relatively quickly and those that are struggling. The Bundesbank raised its outlook for growth in Germany from stagnant to 1.6 percent in 2010. In contrast, EU ministers are very concerned about the state of Greece’s burgeoning deficits. If the laggards of the region are not supported; it could keep the entire Euro Zone from a robust recovery.

Fundamental Forecast for Euro: Bearish
- The ECB holds rates but takes to the hawkish path by slowly removing stimulus
- Advanced Euro Zone consumer inflation reading turns positive for the first time in seven months
- EURUSD on the verge of a reversal of this year’s trend. Will the dollar take the plunge?

The economic docket for the euro may look somewhat reserved over the coming week; but this should not subdue traders into passivity. In fact, the currency may be spurred to dramatic-levels of volatility should the dollar rally or underlying fundamental themes develop. The pressure on the single currency is most poignantly reflected in EURUSD’s standing. This single pair is the most liquid in the currency market and is therefore the benchmark for trends in not just the euro; but for the entire financial market. Through the end of last week, the pair marked a dramatic correction in the span of only a few hours when it plunged from a range and trend-high just below 1.5150 to support that defines a nine-month advancing channel. Arguments can be drawn that the actual trend that represents the backbone of this steady ascent has already been broken; but true confirmation will come from a meaningful push below 1.4800. However, a simple technical break on a single pair cannot define a pervasive trend on its own. To see a true changing of the guard with EURUSD, we will need to see a definitive reversal in underlying risk appetite.

The sell-off this time followed troubling news from Dubai, which asked lenders for a six-month reprieve on payments for about $60 billion in debt.

Benchmark crude prices plunged by 7 percent in early trading, though those declines eased as investors weighed the chances that Dubai’s problems would spread to Europe, Asia and the United States.

It was the fear of frozen credit markets last year that sent crude prices from $147 per barrel in July to about $32 by December.

Crude prices bounced off six-week lows Friday as investors digested the news. The New York Mercantile Exchange, where U.S. benchmark crude is traded, was closed Thursday for a holiday as information from Dubai emerged, which could have exacerbated the selling.

Benchmark crude for January delivery fell $2.20 to $75.76 on Nymex by midday Friday.

At one point, prices had dropped $5.57, the largest dollar decline since April 20 when crude prices tumbled $4.45 to $45.88.

Any decline in the price of crude would likely help most consumers in the short term because gasoline and other fuel prices tend to follow the direction of oil.

Dubai has experienced unprecedented growth over the past decade, and the semiautonomous city-state has spent billions on sprawling man-made islands, an indoor ski slope and the world’s largest tower.

It’s main funding vehicle, Dubai World, said it would ask creditors for a “standstill” on paying back its $60 billion debt until at least May.

That helped send the U.S. dollar higher, which can add more downward pressure on oil prices.

Crude is bought and sold largely in dollars, so investors holding major currencies would have to pay more to buy oil when the dollar rises.

“The strengthening dollar is dislodging a huge amount of speculative capital,” said Jim Ritterbusch, president of energy consultancy Ritterbusch and Associates., adding that energy demand weakness throws yet another wrench into the industry’s recovery.

In other Nymex trading, heating oil fell 3 cents, or 3.1 percent to $1.9599 a gallon. Gasoline for December delivery dropped 5.46 cents to $1.943 a gallon. Natural gas for January delivery climbed less than a penny to $5.17 per 1,000 cubic feet.

In London, Brent crude for January delivery rose 6 cents to $75.05 on the ICE Futures exchange.

The week commenced with markets squarely focused on the first official remarks from Fed Chairman Bernanke since the FOMC meeting two weeks ago. The advanced text of his speech to the NY economics club appeared heavy on strong US dollar rhetoric, providing some hope for the weary greenback. This rhetoric was quickly dismissed as it became clear that a continued low inflation outlook coupled with a dismal employment picture will force the Fed to keep rates low for an extended period of time. In the Q&A session, the Chairman acknowledged that the Fed needs to deal with the possibility of developing asset bubbles, but noted he has yet to see any “large misalignments” in US valuations. The weaker-than-expected US Producer Price Index and Industrial Production data only confirmed Bernanke’s comment that significant challenges still face the US economy and prompted many to speculate that the FOMC’s long period of low borrowing costs might get even longer. As PIMCO’s Bill Gross wrote in his monthly outlook this week, the US needs another 12 months of 4-5% nominal GDP growth before the Fed dares exiting the “0% foxhole, mini-bubbles or not.”

Many participants took Bernanke’s comments to mean the door will remain open to the notion of the US Dollar as a funding currency and the accompanying expansion of risk appetite. The Fed’s Yellen only added strength to this argument (and raised some eyebrows) when she said on Wednesday that the US stock market is not overvalued and credit spreads do not reflect a bubble. In addition, the Fed’s Bullard gave markets a history lesson, warning that the FOMC did not begin rate increases until two to three years after the end of each of the past two recessions. The comment was misinterpreted and immediately sparked rumors that Bullard had said the Fed would be “on hold” until 2012, providing bearish dollar momentum and boosting spot gold to yet another all-time high.

Financial names helped push overall equity markets lower this week, especially after another serving of doom and gloom from Meredith Whitney. On Monday she said “I have not been this bearish on financials in a year” and reiterated that banks will need to raise more capital. The press speculated that the administration would extend TARP through 2010 (last week it was reported that TARP has $239B in unspent funding). On the positive side, October credit card master trust data showed that on the whole net charge offs declined sequentially for a second month in a row, offering more evidence that the business is stabilizing. The October advanced retail sales data jumped dramatically, to a 1.5% gain versus a 1.5% decline in September, although many commentators pointed out that the data owes most of its big gain to auto sales. Continuing discussions of a Tobin Tax on financial transactions lurked in the background in both the US and Europe.

Commodities, not surprisingly, benefited from the strengthening belief that rates won’t change any time soon. Gold prices continue to garner the lion’s share of headlines: the metal hit all time highs above $1,150 late in the week and closed not far below this level. Despite the run up, hedge fund guru John Paulson announced plans to launch a new gold fund on January 1st, backed by his own money. Following in gold’s wake, silver and copper are trading near their best levels of 2009. Oil gave some ground late in the week while distillates underperformed on Friday on concerns that building inventories will outstrip demand. January WTI is now the most actively traded contract and closed below its 20-day EMA for the second straight week.

Treasury prices surged on Monday helped by the fallout from Bernanke’s comments. The 10-year yield has spent the duration of the week under its 200 day EMA for the first time since early October. The move at the short end of the curve has been even more dramatic. Some T-bill rates went negative on Thursday while the 6-month bill hit its lowest rate on record. The 2-year yield made fresh 14-month lows below 0.7% while the curve experienced some steepening midweek. CPI data came in a little hotter than expected buoying long end yields. The benchmark spread has widened out towards its highest level in months at 265 basis points.

In currency trading, the greenback has only benefitted from lower equities and generally supportive comments from a variety of sources, with the exception of some non-conciliatory rhetoric out of the Sino-American summit. Traders were fixated all week on an alleged defense of a binary option with a range of 1.48 to 1.51 by a Far East central bank. The lower portion was tested several times ahead of its expiration at the Friday NY cut, with plenty of central bank speak, data and rumors helping EUR/USD probe both ends of the option. Just ahead of the Friday cut, a particularly creative rumor made the rounds that Ukraine had defaulted on its sovereign debt. In Europe, more factual sovereign ratings worries impacted the euro briefly, as Greece attempted to plug revenue holes in its 2010 budget via a worrisome combination of tax increases and spending cuts. Now that 2009 is winding down liquidity conditions should be impacted in the final weeks of the year by some long-term participants moving to the sidelines to focus on their game-plans for next year.

During his visit to Beijing, President’s Obama voiced his approval of China’s recent comments about moving toward a more market-oriented exchange rate. Chinese President Hu had no comment on the subject. The Chinese vice minister of foreign affairs followed up on the subject later, insisting that China’s stance on exchange rate was very clear, that there had been a misunderstanding about currency reform and that exchange rates were a secondary component in resolving global imbalances. In the wake of the US visit, IMF Chief Strauss-Kahn reiterated that a stronger yuan would benefit China by increasing domestic demand. Note that in his monthly outlook, PIMCO’s Bill Gross forecasted that China may abandon its dollar peg within six months’ time and with it, its own easy monetary policy. On the positive side, ECB Chief Trichet slightly altered his strong dollar statement, noting that a strong dollar was “in the international interest” rather than the usual comment that the US wants a strong dollar. OPEC President Vasconcelos said OPEC needs to “reflect” on pricing oil in dollars. But despite all the talk, the dollar’s current course seems likely to remain intact until the Fed turns up the rhetoric on its exit strategy.

Throughout the week, Central bank officials around the world discussed measures designed to fend off currency appreciation. Officials in India, South Korea and Indonesia expressed concern about capital inflows over inflating stock and real estate prices. Indonesia’s central bank said it is studying limits on inflows to short-term bills. Note that last week Taiwan banned international investors from placing funds in time deposits. Brazil also presented details on its plans to tax capital inflows in an attempt to discourage speculation and excessive strength in the Brazilian Real. The Russian Central Bank mentioned that a Tobin Tax could be needed to curb speculative cross-border currency flows. Some commentators called all this talk by its true name: protectionism.

The week in Asia saw the Bank of Japan leave interest rates unchanged at 0.1% while also upgrading its assessment on the economy in spite of the recent disappointments from consumer confidence, manufacturing activity and tertiary industrial data. In a unanimous decision, BOJ said the decline in consumer prices as well as CAPEX are likely to keep narrowing as exports and production continue to improve. JGB yields rose in the wake of the central bank decision, as the market cheered the positive assessment at a time when many have questioned the timing of the BOJ decision to pull out from its asset buying program. With the latest move, Japan’s central bank is also likely to have widened the rift with the new administration, whose vocal outlook has been significantly more cautious. Ahead of the central bank decision, Finance Minister Fujii said that rising yields could defeat the purpose of government action to ease funding for small companies and urged policymakers to keep price trends in mind when managing the economy. A more vocal critic, Deputy Prime Minister Kan said he planned to take additional steps to communicate to the Bank of Japan that the nation is in deflation. Subsequently, the Japanese November Cabinet Monthly Report officially declared the economy in deflation, the first time it did so since 2006.

Early in the week, the Japanese economy posted its second consecutive quarter of growth in Q3 with better than expected preliminary GDP data, coming in at 1.2% quarter over quarter, showing the best growth rate since early 2007. Despite the strong headline data, analysts remained cautious, pointing to further uncertainty as fiscal stimulus effects wane. Japanese government officials were also hardly impressed, reaffirming commitment to a secondary extra budget totaling as much as Y2.7T, warning about deflationary trends in prices, and pointing to ongoing softness in the labor market.

The Australian dollar was one of the more heavily sold majors for much of the week, falling to a two-week low around 0.9140. On Tuesday, the meeting minutes of the RBA’s policy meeting left the pace of tightening open ended, stressing the short-term significance of supporting business and consumer confidence as economic stimulus fades. Policymakers did reiterate that underlying inflation is consistent with 2010 targets and not as low as initially thought, even with Aussie dollar strength countering those price pressures. Then on Wednesday, the Australian dollar extended its correction from the recent multi-month highs against the greenback and other majors on slowing Q3 wage growth data. Year over year wage growth came in at 3.6%, nearly a 5-year low.

The Kingdom’s cost of living index was 124.3 points in October up from 120.1 points a year earlier, the data published by the official statistics authority showed.

“Although inflation has come down on an absolute basis, month-on-month it still remains high and it could very well average above 5 percent for the year,” said John Sfakianakis, chief economist at Banque Saudi Fransi.

“A slight increase in food prices and high rental costs, as well as dollar weakness, will contribute to inflation remaining historically high.”

The Saudi central bank said earlier this month it kept interest rates unchanged in the third quarter, viewing a further rate cut as unlikely to spur lending while a rate hike was unnecessary given tepid inflation. The Saudi Arabian Monetary Agency (SAMA) held its main rate at 2 percent in the third quarter because of declining inflation and a need to support lending in a banking sector hit by debt restructuring concerns in family firms.

It has slashed its benchmark lending rate by 350 basis points since October 2008 as an oil price collapse sent the top Arab economy into a downturn and inflation fell from record highs.

Analysts have said the Saudi easing cycle was probably over for now and the central bank also needs to watch for potential signs of inflationary pressures after consumer prices rose for the first time in four months in September.

Saudi Arabia, like its Gulf Arab neighbors, pegs its currency to the US dollar. Kuwait dropped the link in 2007, opting for a peg to a currency basket.

The number of loans granted to build or buy houses and apartments climbed in September by 5.1 per cent to 65,505 from August, when they fell a revised 1.9 per cent, the statistics bureau said in Sydney yesterday. The median estimate of 17 economists surveyed by Bloomberg was for a 3 per cent gain.

Rising home loans, stoked by grants from Prime Minister Kevin Rudd’s government, add to signs of an economic rebound that may prompt governor Glenn Stevens to raise borrowing costs on Dec 1 for a third straight month, according to analysts surveyed by Bloomberg. Rising house prices, which jumped 8.4 per cent in the six months through September, are among reasons the bank raised borrowing costs.

“Stevens has flagged the risk of excesses forming in the housing market” and will be keen to see slower demand in coming months as borrowing costs rise and grants are cut, said Helen Kevans, an economist at JPMorgan Chase & Co in Sydney.

The Australian dollar rose to 92.58 US cents at 3.06 pm in Sydney from 92.21 cents just before the report was released. The two-year government bond yield gained three basis points to 4.68 per cent. A basis point is 0.01 percentage point.

First-home buyers accounted for 26.1 per cent of dwellings financed in September, up from 24.7 per cent in August, the statistics bureau said yesterday.

Treasurer Wayne Swan last year tripled to A$21,000 (S$27,005) a grant to first-time buyers of new homes, and doubled to A$14,000 payments for those purchasing existing dwellings. In May, he extended the increases through to the end of September, when they were partially reduced. The payments will be cut to their original A$7,000 at the end of this year.

The number of finance approvals for the construction of new homes surged 8 per cent in September, taking the gain since August 2008 to 84 per cent.

“A housing construction boom is set to kick in from late 2009 and will be a key growth engine through 2010,” Westpac Banking Corp economists including Matthew Hassan in Sydney said in a note to investors.

Mr Stevens last week became the first central banker in the world to raise borrowing costs twice this year, when he increased the official cash rate target to 3.5 per cent, citing a rebound in consumer confidence and Chinese demand for exports.

Mr Stevens will boost the overnight cash rate target by another quarter percentage point next month to 3.75 per cent, according to 14 of 17 economists surveyed by Bloomberg. That would be the first time in history the central bank has boosted borrowing costs at three successive meetings.

Investors are betting that there is a 68 per cent chance Mr Stevens will raise the rate by a quarter point, according to Bloomberg calculations based on interbank futures on the Sydney Futures Exchange at 2.18 pm.

Gross domestic product will expand 1.75 per cent this year and 3.25 per cent in 2010, the bank said on Nov 6. Three months ago, it forecast gains of 0.5 per cent and 2.25 per cent respectively.

Jobs advertised in newspapers and on the Internet fell 1.7 per cent in October, according to an Australia & New Zealand Banking Group Ltd report released in Melbourne yesterday.

Speculation that Mr Stevens will continue to raise borrowing costs, as counterparts in the US, Europe and the UK keep their benchmark rates at historic lows, has driven a 32 per cent gain in the Australian currency this year, pushing it towards parity with the US dollar.