USD: FOMC Preview, 3 Potential Changes from the Fed

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Daily FX Market Roundup 06.17.14

USD: FOMC Preview, 3 Potential Changes from the Fed

GBP: 1.70 Rides on the BoE Minutes

Euro: German Investor Confidence Plunges

Dovish RBA Minutes Drives AUD Sharply Lower

NZD: Dairy Prices Rise for First Time in 4 Months

USD/CAD Rebounds on Lower Oil Prices

Yen Crosses Supported by Rally in USD/JPY

USD: FOMC Preview, 3 Potential Changes from the Fed

Investors are buying dollars ahead of the Federal Reserve’s monetary policy announcement. The central bank is widely expected to reduce asset purchases by another $10 billion, a move that will reduce the amount of stimulus provided to the economy on a month-to-month basis. While this announcement alone should be positive for the dollar because it pushes the Fed closer to ending Quantitative Easing, the market has already discounted a steady pace of tapering – in the past we’ve seen the dollar and Treasury yields fall instead of rise on tapering. What is different this time around is that in addition to announcing a reduction in asset purchases, the Fed is also expected change its forecasts and the dollar’s reaction will depend on how Janet Yellen explains those changes. We are looking for 3 potential adjustments to the Fed’s forecasts:

1) Lower Unemployment Rate – Back in March the “dots” in the Fed’s forecasts show that policymakers expect the unemployment rate to be between 6.1 and 6.3% in the fourth quarter. According to the latest labor market report, the unemployment rate has already fallen to 6.3%, the top of the Fed’s range. As a result, the central bank finds themselves in the uncomfortable position of possibly adjusting down the lower end of their unemployment forecast range to the 5 handle. A move that could be interpreted as positive for the dollar because it reflects a continued normalization of labor market conditions.

2) Higher Inflation Forecast – At the same time, the Fed is expected to upgrade its inflation forecast. Just this morning, we learned that consumer prices rose 0.4% in the month of May, bringing the annualized pace of CPI growth to 2.1% from 2%. Excluding food and energy prices, consumer prices rose at its fastest rate since October 2009.

3) Weaker GDP Forecast – Their expectations for growth on the other hand is expected to be revised lower due to the larger than anticipated contraction in growth in the first quarter. While this may appear to be discouraging, the economy has been gaining momentum in the second quarter.

A forecast of higher inflation and lower unemployment suggests that the Fed is moving closer to achieving their goals and if Janet Yellen acknowledges that in her press conference, the dollar should extend its gains against all major currencies. However if she downplays these improvements and stresses that the unemployment rate remains high so therefore a highly accommodative stance remains appropriate, the boost to the dollar will be limited. There won’t be any talk of when rates will rise but we’ll be watching is see if they decide to halt reinvestments. The bottom line is that the dollar should have an upward bias given the expected changes to the Fed’s unemployment and inflation forecasts.

GBP: 1.70 Rides on the BoE Minutes

Sterling’s ability to break through 1.70 hinges exclusively on tomorrow’s Bank of England minutes. After Mark Carney’s hawkish comments last week, investors will be looking for confirmation that the central bank’s monetary policy bias has officially changed in that they are now actively thinking about when to raise rates. Back in May when the Quarterly Inflation Report was released the BoE went out of their way to avoid acquiescing to the market’s speculation for earlier tightening and a month forward, Carney is now talking about raising rates sooner. So the change must have occurred at the June monetary policy meeting. The minutes will provide important insight on what drove the shift in stance, which is especially important considering that this morning’s consumer price report surprised to the downside. Economists were looking for CPI growth to slow to 0.2% from 0.4% but instead it fell 0.1%. This drove the annualized pace of growth down to 1.5%, a 4.5 year low. Supermarket competition and lower airfares led to undershooting and while these prices tend to be volatile, the trend of CPI growth is an argument against tightening. The strong housing market on the other hand is one of the reasons for why the central bank wants to tighten. According to ONS data, house prices jumped 9.9% in the month of April, the strongest pace of growth since June 2010. If the BoE minutes reinforce Carney’s hawkish monetary policy bias, sterling will make another run through 1.70 but if there is a lot of ambiguity in the minutes and not much indication of an urgency to raise rates, sterling could give up its gains quickly and drop below 1.6900. We view any move below 1.6850 as an attractive opportunity to buy GBP/USD at lower levels. Aside from the BoE minutes, MPC members Weale and Haldene are scheduled to speak and the market will be looking to their comments for more clarity on the central bank’s monetary policy plans.

Euro: German Investor Confidence Plunges

A decline in German investor confidence and a rise in U.S. Treasury yields drove the euro lower against the U.S. dollar. Even with today’s move however, the currency pair remains confined between 1.35 and 1.36. Whether 1.35 gives way will depend on the dollar’s reaction to the FOMC rate decision, as there are no major Eurozone economic reports scheduled for release on Wednesday. According to the German ZEW survey, investor confidence plunged in the month of June. While the current conditions index rose to 67.7 from 62.1, the more important expectations component dropped to 29.8. This was not only the sixth straight month that confidence missed expectations but the index also fell to its lowest level since January 2013. Euro weakened on the back of the report but the more optimistic outlook for the Eurozone limited its losses. While easing by the ECB helped to bolster confidence in the region, the German economy is expected to slow after a strong first quarter. The ZEW survey is important but not as significant as the PMI or IFO reports which explains why EUR/USD continues to hold above 1.37.

Dovish RBA Minutes Drives AUD Sharply Lower

All 3 of the commodity currencies traded lower today but the steepest losses were experienced in the Australian dollar. Having traded within arms reach of its year to date high, less dovish RBA minutes were needed for the currency to make a run for 0.9460 and given the nonchalant attitude of RBA statement, there was a reasonable chance of that happening. Unfortunately the minutes were slightly more and not less dovish, resulting in a steep decline in the Australian dollar. Aside from repeating that the “current accommodative stance is likely to be appropriate for some time,” they also said it is becoming “difficult to judge the extent to which (low interest rates) would offset the expected substantial decline in mining investment and the effect of planned fiscal consolidation.” The uncertainty in their outlook is more dovish because it reflects the possibility of increased downside risks. Although AUD/USD has taken the brunt of the selling, we think the minutes are particularly bearish for AUD/NZD. For the first time in 4 months, dairy prices finished higher at the global dairy trade auction. While it is too early declare this a bottom, the stabilization in prices is great news for the New Zealand dollar. Current account numbers are scheduled for release this evening and the deficit is expected to have returned to surplus in the first quarter. As for the Canadian dollar, the decline in oil prices helped to ease the downside pressure on USD/CAD.

Yen Crosses Supported by Rally in USD/JPY

Thanks to the rally in USD/JPY, all of the Japanese Yen crosses with the exception of AUD/JPY traded higher today. U.S. yields rose strongly during the North American trading session and overnight, the Nikkei rebounded. As mentioned on Monday, a quiet Japanese calendar means that the Yen will trade on the market’s demand for dollars and risk appetite. Japan’s monthly trade balance is scheduled for release this evening and unfortunately a decline in exports is expected to trigger significant deterioration in trade activity. While this could affect Japanese equities, the impact on the Yen should be limited ahead of the FOMC rate decision.

Kathy Lien
Managing Director

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