We got no blockbusting policy from Jackson Hole on Friday, but the Fed chairman failed to rule out further action if the US economic outlook continues to deteriorate.

He talked about fiscal policy, probably paving the way for President Obama to announce stimulus measures in a speech on Sept 5th he also sounded reasonably positive on the economic recovery, which may or may not turn out to be ill judged given we have an important non-farm payroll number coming up this Friday.

Other US data of note this week include the minutes from the last FOMC meeting on the 9th August and consumer confidence, both due this afternoon.

Given the importance of Friday’s speech it is unlikely that we get anything unexpected in the Fed minutes.

Sterling should take a bit of back seat this week, it has been stuck in trading ranges against both the Dollar and Euro in recent weeks and with a lack of any substantive data due this week we can expect that to continue.

The little data that is due this week is mostly housing related and includes mortgage approvals and the Nationwide house price survey along with net consumer credit, manufacturing and construction PMI later in the week.

The Euro has started the week on a roll, gaining against both the Dollar and Sterling even without any real data to back up the rally.

The merger between two of the struggling Greek banks seems to have lifted market sentiment, but quite how two bad banks makes one good one is beyond logic!

It’s all about Jackson Hole and ahead of today meeting the US Dollar index is likely to maintain its place in towards the middle end of its recent 73.47 – 75.12 range helped by weaker equity markets.

Bernanke will likely keep all options open but there are still some in the FOMC who do not want to embark on QE3.

Although the US Dollar may be saved from a further drubbing the commitment to maintain exceptionally accommodative monetary policy through Q2 2013 has contributed to a relative reduction in US bond yields and in turn is acting to restrain the US currency.

A likely revision lower to US Q2 GDP will not help the USD in this respect.

One currency in particular that is reactive to yield differentials is USD/JPY, which registers an impressively high correlation with US – Japan yield differentials.

Attempts this week by the Japanese authorities to encourage capital outflows and a downgrade of Japan’s credit ratings by Moody’s have done little to weaken the JPY.

Even the usually bearish JPY Japanese margin traders have been scaling back their long USD/JPY positions over recent weeks while speculative investors remain overly long (well above the three-month average) JPY according to IMM data. The risk of a shake out of long JPY positions is high but unless yield differentials reverse renewed JPY weakening looks unlikely in the short-term.

So far this week euro has shown impressive resilience despite weak data in the form the German August IFO business and ZEW investor confidence surveys.

However, there is a risk of euro weakness should Bernanke not hint at QE3, with the currency already trading around the bottom of its multi-day range.

FED Chairman Ben Bernanke has hinted that further Quantitative Easing is unlikely, saying instead the Fed is committed to keeping interest rates low until at least 2013.  

One of the aims of zero interest rates and QE is to force money into risk assets, and it looks like equity markets are setting up for the expectation of a further round of easing being announced. But they may be bitterly disappointed.

The key differences from last time are that the spectre of deflation, one of the key motivators for QE2, is not the threat it was a year ago and there is also dissent from 3 Fed board members further clouding the Feds ability to implement any new round of QE.

So how does the Fed’s announcement impact FX markets?

Safe haven currencies such as the Swiss franc, Aussie Dollar and the Scandinavian Krona’s look set to be very dependant on the outcome of Friday’s speech.

They have all benefitted from diversification out of Dollars and the prospect of further money printing by the US so we can expect significant moves in both directions depending on the content.

Special attention needs to be paid to the Swissie which has the SNB on the other side of the trade should QE3 go ahead.

Along with the US announcement (or not) Friday also sees UK GDP figures released. If we take the overall tone of recent UK data as a guide it is hard to be optimistic about UK growth.

There seems to be significant economic headwinds, set to get stronger as government spending continues to fall and companies hoard cash instead of hire workers.

In line with forecast is the best we can hope for. Later in the day, but before said speech, US GDP is also released along with the University of Michigan confidence survey.

The major worry for markets remains the length and severity of the existing ‘soft patch’ in the economy.

Bernanke believes it will be temporary but the fall in equity markets over recent weeks suggests that there has been a deviation between stock market expectations and reality.

The Greenback may in fact be hitting a medium term bottom with the fact that the Fed is not considering additional QE.

The negative Fed stance combined with a vigilant reaction to the Greek government’s passing of a confidence motion suggests that markets will remain watchful over the near term.

Without a doubt, comments by the Greek opposition that they will not support further austerity measures ruined any hopes of agreement and will add another obstacle towards an easing in Greek tensions.

The continued bickering between EU officials over private sector participation in any debt rollover in addition to uncertainty over how ratings agencies will respond, threatens to keep sentiment under pressure.

The EUR has remained surprisingly resilient but its muted reaction to the passage of the confidence motion has given way to some weakness and the currency remains a sell on rallies.

Sterling suffered yesterday, weighed heavily by the relatively dovish Bank of England MPC minutes in which some members were even discussing further QE.

The currency faces its toughest battle for months as it breaks through key psychological 1.60 level and currently stands 1.5987 and GBPEUR:1.1223.

He also said that he is satisfied that the economic conditions in the US remain positive for growth, even in light of the recent weak employment and manufacturing data over the past few weeks.

Mr Bernanke continued to suggest the US economy is producing well below its potential but the current weak data flow is a “soft patch” and there would be a pick up in activity in the second half of 2011.

US stock markets immediately reversed small gains once the Fed Chairman began his talk and finished down on the day.

The US Dollar also strengthened on the news and looks set to continue that path today with Bourses in Europe opening the day down and the risk-on risk-off see saw continuing to play out across the markets.

With the ECB not likely to raise rates this Thursday, the closely watched press conference by ECB President Jean-Claude Trichet becomes the potential market mover.

The market seems to be suggesting there is a high probability that Mr Trichet will indicate a rate increase in July.

In the strange world of Central Bank communication, he will not say this directly but indicate this by mentioning “vigilance” when talking about the Banks stance towards inflation.

Given the size of the move in the Euro against the Pound and Dollar there seems to be a big chance that the market will be disappointed.

We have several American data releases on the menu this week but possibly the most significant for the US Dollar exchange rate will be the minutes of last months FOMC meeting.

The Fed’s attitude at this point will be the major factor of whether the Dollar can maintain its rally over the next few weeks.

The lack of encouragement in US bond yields suggests that USD drive could slow, with markets likely to shift into wide ranges over coming weeks.

One should also consider which currencies will suffer more in the event of further USD gains.

The relationship linking the USD index and EUR/USD is extremely strong signifying that the USD gains are mainly a result of the single European currencies woes.

Apart from the EUR, GBP, AUD and CAD are the most susceptible major currencies to USD strength as many emerging market currencies including ZAR, TRY, SGD, THB, IDR, and MXN, are all highly susceptible to the impact of a stronger USD.

Japanese officials have been avoiding further forex interference blaming the drop in USD/JPY over recent weeks on general USD weakness in spite of the move towards 80.

However, this stance is not really backed up by correlation analysis which shows that there is only a very low sensitivity of USD/JPY to general USD moves over recent months.

One explanation for the strength of the JPY is strong flows of portfolio capital into Japan, with both bond and equity markets registering net inflows over the past four straight weeks.

Another week begins, and the spotlight passes from one central bank head to another – Sir Mervyn King of the Bank of England.

Last week ECB President Trichet used language that indicated rate rises are just around the corner (sending the Euro markedly higher against the Pound and Dollar) and this week it is the turn of Bank of England and Mervyn King with the monthly MPC meeting scheduled this week.

After last month minutes showing three members voting for a rate rise, Sterling has enjoyed a bounce against the Dollar – if not the Euro – and if the Bank does decide to raise rates we can expect further gains.

However, King seemed to rule out any symbolic rate rises in the inflation report last month and given the current spike in crude oil stemming from unrest in the Middle-East, the doves on the MPC will be stressing that the UK economic recovery cannot be put in jeopardy by raising rates.

King has also drawn criticism from the city with comments over the weekend that city institutions are too short-term orientated.

Given that Mr King once said he thought central banking should be a dull subject, the thinking may be that he seems to be overplaying his hand and that could hurt the credibility of the bank if he is seen to be overly political.

The ECB meeting has been the catalyst for the recent Euro strength, but any rate rise in the Eurozone would probably only be beneficial for the Germans.

The struggling periphery PIGS nations will certainly not welcome any move – especially the Spanish whose mortgages are prices from one year Euribor – which jumped 14 basis points immediately after Mr Trichets announcement.

In the face of rises oil prices, which acts as a global tax, raising rates at the behest of the Germans risks derailing any sustainable recovery in nations trying extremely hard to get their public (and private) finance back in order.

Today’s highlight is set to be the ECB meeting and subsequent statement and Q&A by ECB President Jean Claude-Trichet.

In particular any mention of upside danger in relation to the inflation rate will be interpreted as hawkish given Mr Trichet went to extraordinary lengths last time to avoid commenting on the above target inflation rate in a hawkish way.

This morning has seen Eurozone PMI data miss forecast slightly but any effect was more than offset by positive German retail sales and French unemployment data (which Trichet will undoubtedly cite when he talks about a broad based recovery in the Eurozone, laughable when you think about the state the periphery economies are in).

With the large amount of data and the ECB meeting this mornings Euro trading has been volatile, with the single currency up around half a cent against Sterling and the Dollar.

Fed Chairman Ben Bernanke had been the focus over the last few days with his statements to both houses (which we so similar he may as well had the first one taped and played back).

The real interest was in the Q&A session after the prepared address, in which Mr Bernanke talked about further QE and the Fed’s plan regarding short term interest rate.

The overall impression was that the Fed are not in a hurry to raise rates and that they will still not rule out further easing if the economic situation, especially in the labour market continues to deteriorate.

For the Dollar this meant mild softening as the speech progressed but all of Sterling’s gains yesterday afternoon have been given back in early trading this morning.

Policymakers are focusing on inflation, but the perception of dangers being created remain diverse with the Bank of England and Federal Reserve still erring on the swift return to normality whilst the ECB argue that pressures will persist and that higher inflation will become embedded.

There is little chance that official rates will be raised tomorrow, but the market now has it in mind that Euro rates will be the first ones to go, with Sterling and Dollar interest rates likely to remain where they are until the middle of the year.

Turning back to yesterday, BoE members appeared before a Parliamentary Treasury committee, testifying on financial regulation, but touching on various other things.

They talked about the problems that would be created for the MPC by further increases in commodity and energy prices, but warned that to raise interest rates as a gesture would be self-defeating and would not be sanctioned.

They were however quite bullish on the recovery commenting that UK growth had picked up during the first couple of months of the year and Sterling stopped weakening.

Ben Bernanke was also testifying yesterday afternoon, this time before Congress in his semi-annual address on monetary policy.

Like his BoE counterparts, the Fed Chairman spent most of his time re-affirming previously communicated policy decisions, but did say that there was no strategy for debasing the US Dollar and referred to the need for a sustained improvement in job creation.

All eyes therefore on the ADP number this afternoon ahead of Friday’s non-farm payrolls data.

With little data of note out yesterday, this left the stage clear for US Federal Reserve Chairman Ben S. Bernanke’s speech to the House Budget Committee. 

Whilst the fall in the jobless rate in December and January “do provide some grounds for optimism,” he warned that “with output growth likely to be moderate for a while and with employers reportedly still reluctant to add to their payrolls, it will be several years before the unemployment rate has returned to a more normal level”.

Bernanke and the Federal Open Market Committee are waiting for further proof of a durable pickup in the job market as they press forward with their plan to buy $600 billion in Treasury securities to boost the pace of recovery.

In its January 26th statement, the panel said the recovery “has been insufficient to bring about a significant improvement in labour market conditions”.

Bernanke’s remarks, his first since a Labor Department report on February 4th showed the jobless rate unexpectedly fell to 9 percent in January, were similar to remarks he gave last week at the National Press Club and testimony last month to the Senate Budget Committee.

Today it is all about the UK with December’s industrial production release at 9.30am showing a slightly lower than expected (but weather related) +0.5% m/m.

A slightly disappointing outcome but not far enough away from consensus to cause anything but a minor wobble in Sterling’s value.

All attention now shifts to the midday announcement from the MPC. The majority of market players are assuming no change in the level of liquidity addition and no shift in interest rates.