The price action in the FX market today is very similar to what we saw at the beginning of last week. The U.S. dollar is trading strongly against high beta currencies such as the GBP, AUD, NZD and CAD but is weaker against the EUR and CHF. The only outlier is USD/JPY, which extended gains into the North American session. While equity futures are basically unchanged the fact that the U.S. 10 year Treasury yield is closing in on 2.2% indicates that we have a segmented market right now with deleveraging resuming in the comm dollars. It is clear that there is more confusion than clarity on the Federal Reserve intentions because the latest market swings were triggered by articles from Fed watchers speculating on what Bernanke will say on Wednesday.

Last week Hilsenrath of the WSJ claimed that the Fed will make a point to downplay expectations and distinguish the difference between tapering and tightening. This week, the Financial Times claims that Bernanke will signal that the Fed is close to tapering. What we are amazed about is how the market can be surprised by any of these articles because they don’t say anything new. Since the last Fed meeting, a number of policymakers have said the central bank could taper asset purchases in a few months and some of these same officials have also said that monetary policy will remain extremely accommodative. We believe this is the same message that the Federal Reserve will leave us with tomorrow. This morning’s U.S. data didn’t help. Consumer prices rose 0.1% and excluding food and energy prices rose 0.2% in May. Housing starts rebounded 6.8% after dropping 14.8% the previous month while building permits dropped 3.1% after rising 12.9%. For the most part, inflationary pressures remain muted and the housing market continues to recover.

Meanwhile the euro is performing well this morning thanks to the rise in Eurozone and German investor sentiment. The ZEW survey for the region 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 European Central Bank taking additional steps to stimulate the economy, investors are looking for a stronger recovery. The strength of the euro contrasts with the weakness of sterling and aussie. UK consumer prices increased more than expected but the GBP was driven lower by EUR/GBP buying. The AUD is the worst performer, down almost 1% against the USD after the Reserve Bank of Australia minutes reminded everyone that the central bank is looking to ease again and their views have not changed because the currency weakened. In fact, they felt the exchange rate could depreciate further over time as the terms of trade declined and a decline in terms of trade is not positive for Australia’s economy.

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