Dollar Drops on Dovish Fed Chatter, BOJ in Focus

A top Fed official shot down near-term tapering speculation ahead of Bernanke's testimony. The euro was the top performer while the pound lagged after soft UK inflation data. The Bank of Japan decision in is the major event on the calendar. GBP traders await the release of Wednesday's retail sales, followed by Thursday's release of the revised UK Q1 GDP, which may produce a positive combination for the pair and possibly cap EURGBP. Both of last night's EURUSD are in progress as is GBPUSD, both USDCAD, 1 CADJPY, 2 EURGBP and 1 silver, all seen in the latest Premium Insights.

NY Fed President Dudley said risks to the Fed's monthly QE program are double-sided, saying purchases could be increased or decreased. He seemed to brush off the idea of tapering in the next few months, saying it would take a 'material' change in the labor or inflation outlook to change course.

St. Louis Fed President Bullard – who has been hawkish in the past – was more explicit, saying he can't envision a good case for tapering unless inflation turns around.

The US dollar's response to the comments was somewhat surprising. In the past, comments promoting tapering have boosted the dollar but the opposite didn't occur here. The lack of a significant dollar sell off following the comments suggests either 1) more than Fed talk is underpinning the dollar rally 2) the market wants to wait and see what Bernanke says Wednesday.

The market could also be apprehensive about the upcoming Bank of Japan rate decision.

The BOJ will get a final, and perhaps invaluable, piece of information before its announcement. At 2350 GMT, April trade balance numbers will be released. This is the first month of data following the doubling of QE and drop in the yen in early April. Exports are expected to rise 5.4% y/y with imports climbing 6.7% y/y.

For Aussie traders, the Westpac consumer confidence numbers will be released at 0030 GMT and the DEWR report on skilled vacancies at 2100. It's rare for either data point to move the market.

Expectations for the BOJ are fairly low but there could be significant policy signals in the bond market. In the past 10 days, 10-year JGB yields have risen to 0.88% from 0.60% and officials are worried. The BOJ response could be as simple as jawboning but they could go much further. The problem is that, in terms of raising inflation expectations, the higher yields are positive.

If the BOJ signals a strong stance against rising yields the yen is likely to drop. If they signal a willingness to let yields rise, the yen could turn around.