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Will Bernanke cause a tantrum before the New Year?

Vladimir Nabokov once said that “complacency is a state of mind that only exists in retrospective – it has to be shattered before being ascertained”.

When Ben Bernanke steps to the podium for the second last time at the Federal Reserve  on Wednesday, we may find out whether investors have been too relaxed about the prospect of a December taper. Although a move before the New Year is generally considered unlikely, there is a substantial risk that all the good little boys and girls around the financial world suddenly discover that Santa Claus doesn’t exist – meaning that a tantrum is a distinct possibility.

As a result, nerves are increasingly on edge across the currency markets. The dollar is outperforming commodity-linked and emerging market units this morning as investors seek protection against international volatility and trim positions that might be exposed in the event of a negative shock.

The yen is trading well north of the 100 mark on the expectation that policymakers will encourage the Bank of Japan to step up its monetary stimulus efforts – widening the dilution gap against the dollar over the next year. In contrast, Euro bulls are in an offensive posture after the Flash Eurozone Composite Purchasing Managers’ Index rose to 52.1 in December from 51.7 last month, pointing to a gradual expansion in economic activity despite weakness in France.

The Canadian dollar is also trading with a more positive bias, continuing to receive a lift from Thursday’s comments by Bank of Canada Governor Stephen Poloz. He said that the institution remains focused “on inflation….the markets will grind out the exchange rate as they see fit” – and that policymakers are making “more a movement towards honesty than dovishness”. Although the currency’s gain looked minor to hedgers who retain expectations anchored closer to 1.03, it surprisingly posted the strongest performance among the majors last week.

We suspect that the central bank’s shift in tone will ultimately do little to alter the fundamentally bearish outlook on the Canadian dollar, but a pause in the Bank’s subtle jawboning could certainly help to reduce underperformance relative to the dollar in the short term.

With the Fed meeting looming, liquidity ebbing, and year-end position squaring occurring, we cannot emphasize enough that hedgers should be putting market entry strategies in place ahead of any potential turbulence. Limit orders and currency options are designed to translate volatility into a positive impact on the bottom line – without requiring that financial decision makers spend every second watching the markets.

Remember – luck is mainly a matter of preparation meeting opportunity. If your business isn’t prepared for movement between now and the end of the year, the opportunity may pass you by…

Further reading:

Bernanke’s last dance; What to expect this week?

Karl Schamotta

Karl Schamotta

Director, FX Strategy and Structured Products at Cambridge Mercantile Group.