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USD: FOMC Scenarios, Changes In The US Economy
Corporate Digest | 19 June 2013
By: Kathy Lien
Articles (9) Profile

This article is written by Kathy Lien, Managing Director of FX Strategy at BK Asset Management, and has been republished with permission on Shares Investment.

The Federal Reserve will be making one of its special quarterly monetary policy announcements on Wednesday (US) and based on the price action of the currency, equity and bond markets, there is very little consensus on what is expected from the central bank. While no one expects the Fed to cut interest rates or alter its asset purchase programme this week, there’s a lot of confusion on what the Fed Chairman could say about their monetary policy intentions going forward. Based on the rally in U.S. stocks, equity traders don’t except Bernanke to sound overly eager about tapering asset purchases. Bond traders who initially drove bond yields above 2.2 percent changed their minds as the day progressed. Currency traders are just as confused with the dollar weakening against the EUR and CHF and strengthening against the JPY, GBP, AUD and CAD ahead of the Federal Reserve’s monetary policy decision.

While there are a number of potential scenarios for tomorrow’s event, we are focusing on 2 key possibilities. If Bernanke says tapering does not equal tightening but makes it unambiguously clear that they plan to vary the amount of bonds purchased under their Quantitative Easing programme later this year, the dollar should rise. However if Bernanke straddles the fence and spends more time distinguishing the difference between tapering and tightening, the dollar should sell-off as this would suggest that the Fed’s eagerness to adjust asset purchases has weakened. Based on the rise in bond yields and the volatility in the treasury market in general, Bernanke may opt to err on the side caution and give the market as little as possible. Since the central bank last met, 10 year Treasury yields increased 50bp from 1.63 percent to 2.2 percent. The performance of the U.S. economy has also been mixed.

The following table shows how the economy has changed since 1 May. Overall, consumer spending improved and job growth accelerated but inflation ticked higher on the consumer level and manufacturing plus service sector activity slowed. Housing market activity is also mixed and taken together, these reports show an uneven but continued recovery in the U.S. economy. This is part of the reason why the Fed is expected to lower its GDP forecasts. For the central bank, the pullback in service and manufacturing activity is another reason why Bernanke may want to avoid fuelling expectations for Fed tapering and by extension, drive yields even higher. So while a number of policymakers have said the central bank could taper asset purchases in a few months, the stronger message could be that monetary policy will remain extremely accommodative.



















EUR – Lifted By Stronger Investor Confidence

The Euro traded higher against all of the major currencies today thanks to the improvement in Eurozone and German investor sentiment. The Eurozone ZEW survey rose to 30.6 from 27.6 and while investors grew less optimistic about current conditions in Germany, their confidence in future conditions improved with the expectations component of the German ZEW rising to 38.5 from 36.4. With the European Central Bank taking additional steps to stimulate the economy, this data indicates that investors are looking for a stronger recovery. In a farewell conference for Bank of Israel Governor Stanley Fischer today, European Central Bank President Mario Draghi talked about ECB monetary policy. He said the central bank would consider non-standard measures including the possibility of negative deposit rates. Draghi said, “We will look with an open mind at these measures that are especially effective in our institutional setup and that fall within our mandate.” Yet he warned that these non-standard measures could also lead to unintentional consequences. Parts of the Eurozone have been unresponsive to monetary policy and Draghi has set to regain its steering capacity. He pointed out that the introduction of non-standard policy measures along with standard measures helped prevent the materialisation of deflation risk. The euro has been rising this year as confidence in the Eurozone is restored. Draghi also said that the exchange rate is “important for growth and price stability.” Survey data suggest some recovery in the Euro-zone but from low levels and as such “monetary policy will remain accommodative for as long as necessary.” The central bank will “monitor very closely all incoming information on economic and monetary developments and stand ready to act if necessary.” No major Eurozone economic reports are scheduled for release tomorrow, letting the market focus on FOMC.

GBP – Hit By EUR/GBP Demand

The British pound fell aggressively against all of the major currencies despite signs of higher inflation. The weakness was driven entirely by demand for EUR/GBP, which saw its strongest gain in nearly a month. UK consumer prices increased more than anticipated in the month of May. Economists expected a rise of 0.1 percent but CPI rose 0.2 percent month over month and 2.7 percent on an annualised basis. The rise in inflation was driven by the previous month’s increase in clothing prices and airfares and decrease in fuel costs. The Bank of England expects inflation to be around 3 percent in the third quarter. Many BOE policy makers have rejected Governor King’s call for more stimulus on the fear of rising inflation. The minutes from the most recent monetary policy meeting, which was also King’s last will be released tomorrow. The central bank left monetary policy unchanged but the meeting came on the heels of stronger manufacturing, service and construction sector activity, which suggests that there could a hint of optimism within the central bank. If one less member voted in favour of additional asset purchases, sterling will soar.

AUD – Extends Losses On RBA Minutes

The Australian dollar extended its losses against the greenback following the release of the central bank meeting minutes. The Reserve Bank of Australia reminded the market that the central bank is looking to ease again and their views have not changed just because the currency weakened. They continue to feel that the “inflation outlook might provide scope for further easing” and felt the “exchange rate could depreciate further over time as the terms of trade declined.” While the AUD/USD is trading below 95 cents, there may not be much downside considering that speculative short positions are record highs. Also, if the Federal Reserve’s monetary policy decision ends up driving the dollar higher against the AUD, the gains could be sharp as shorts cover. Australian leading indicators are due for release this evening along with New Zealand’s current account report. Improvements in New Zealand trade activity in the first three months of the year should help narrow the deficit. No economic data is expected from Canada but the rise in oil prices should limit losses in the loonie.

JPY – Japanese Officials Defend BOJ Policy

The Japanese yen weakened against most of the major currencies today thanks to the continued recovery in U.S. equities. Japanese data on the other hand was weaker than expected with industrial production growing less than anticipated in April. Industrial production gained 0.9 percent month-to-month, and fell 3.4 percent year-to-year. The recent volatility in the equity and currency market isn’t going to be kind to Japan’s economy. In an interview today Japan Economy Minister Akira Amari said, “While market movements are important in themselves, the government isn’t making policy to pander to markets and should have confidence that markets will follow its policies. If we are confident and improve the real economy, stock prices will naturally follow.” Amari advised the BOJ to communicate clearly with financial markets and praised the BOJ for their plans to reach 2 percent inflation. Finance Minister Aso also said he thought the BOJ made the right decision about maintaining its generous QE programme when they last met. Japanese trade numbers are scheduled for release this evening and unfortunately the rising yen is expected to drive the deficit higher.

Kathy is a well-known expert in the Forex world and has over 10 years of trading experience in the forex market. She is frequently seen and quoted on international media platforms such as CNBC.

Please click here for more information about this author.

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