The U.S. dollar continued to perform well this morning despite weaker economic data. The U.S. current account deficit widened to its largest level in a year due to weaker trade activity and lower income. We knew that the number was going to be weak because the trade deficit expanded significantly in the fourth quarter but the magnitude of the deterioration was larger than everyone had anticipated. The current account deficit was -$124.1B in Q4 compared to $107.6B for Q3. Import prices also rose less than expected last month. Prices increased 0.4 percent in February compared to an estimate of 0.6 percent. The current account report confirms that GDP growth in the fourth quarter was weak while import prices signal that inflationary pressures may not be as strong as everyone fears. With Greece falling off the headlines, concerns have shifted to the high level of oil prices. The rise in the cost of energy has been gradually seeping into inflationary measures around the world but weak demand has capped the flow through into prices. According to yesterday's FOMC statement, the Federal Reserve is not worried about the long term impact of higher oil and gas prices. They believe that the recent increase will only push up inflation temporarily. Even the Federal Reserve's stress test, which 4 banks failed did not stop, investors from buying dollars.
The reason is because U.S. yields are on a tear. Ten year bond yields broke out of a 4 month consolidation to rise to its highest level since late October. The white line in the following chart is the 10 year U.S. yield and the yellow line is USD/JPY. The simultaneously rise in U.S. yields and stocks has made the dollar extremely attractive to foreign investors who have been burned by the deterioration in credit quality in Europe. USD/JPY rose to its highest level since April 2011 and as long as Bernanke does not kill the rally by downplaying the central bank's optimism, the pair will be on its way to testing resistance at its prior high of 85.52. EUR/USD broke below its 50-day SMA and if it ends the day below the moving average, a break of 1.30 appears likely. Bernanke will be speaking at 10:00 AM ET or 14:00 GMT. Optimism from the Fed Chairman will drive the U.S. dollar and U.S. yields even higher but cautionary comments could lead to profit taking. We expect Bernanke to recognize the improvements in the U.S. economy but at the same time remind investors that monetary policy remains easy. Another 6 months of improvements in the U.S. economy is needed before the Fed will even consider changing their game plan.