The weaker than expected 2.5% rebound in February durables following the 9.3% plunge in January (revised from earlier 8.7%) is accelerating the dollar sell-off predominantly against the yen and to a lesser extent against European FX and antipodean currencies.

Yen surges back taking risk aversion with it

The yen rose across the board amid a resurgence of risk aversion following unsubstantiated rumors of a military confrontation between the US and Iran in the Persian Gulf and repatriation flows by Japanese institutions ahead of the end of the fiscal year by end of the week. Despite the fact that the Iran rumors were refuted by US authorities, the current impasse involving the detained British sailors by Tehran is raising the fear scale on the geopolitical front, contributing to an 8% spike in crude oil to $68 per barrel, the highest level since early September. Gold prices also pushed higher, reaching $668 per ounce, almost a 4-week high. News that number 3 US home builder Lennar withdrew its 2007 earnings forecast have also helped resurrect fears on the escalation of the worsening in the US housing sector.

Bernanke??™s inflation vigilance may be overshadowed by his housing concern

Attention shifts to Fed Chairman Bernanke??™s 10:30 am EST testimony on the economic outlook before the Joint Economic Committee of US Congress. Although we do expect Mr. Bernanke to reiterate the Fed??™s inflation discomfort, we expect the market??™s scrutiny on Bernanke??™s concern with the housing market decline in general, and sub-prime loan defaults in specific to generate a downbeat dollar reaction and modest declines in US yields. Mr. Bernanke may be pressured to come up with a more detailed assessment regarding the deterioration of the US housing slowdown beyond simply describing it as ???adjustment ??¦is ongoing??? as was indicated in last week??™s FOMC statement. Mr. Bernanke may not be expected to sound off the usual sanguine tone on housing, especially when testifying to a group of anxious lawmakers, who are representing constituencies affected by the sub-prime fallout.

As Mr. Bernanke gives a more detailed view on the Fed??™s downgrading of the housing sector, we expect the market to continue dragging the dollar lower and trigger further yen gains. Recall that in the semi-annual Congressional testimony last month, Mr. Bernanke said: ???The distress in the sub-prime area is a significant concern???.

Thus the bottom line is that it is unlikely to expect currency markets to push up the dollar on a hawkish take by Bernanke at a time when the housing uncertainty is far from over and the impact on sub-prime lenders and home builders is unknown.

Yen broadens gains amid fresh carry trade unwinding, eyes 116.40

EURUSD struggles at 1.3370

Sterling eyes 1.96, risk from unwinding