The FX market is trading primarily on country specific factors this morning and not risk appetite because the dollar is up against the euro and Swiss Franc and down against the British pound, Japanese Yen and commodity currencies. The story is Asia versus Europe. An improvement in Chinese manufacturing activity in October provided a boost to commodity currencies and a cushion for risk. However higher European bond yields, a decline in German manufacturing and service sector PMI along with a weaker than anticipated IFO report prevented the euro from participating in the rally. While U.S. stocks are trading slightly higher this morning, the 3.5% decline in the S&P 500 over the past 4 trading days has shifted the markets’ tone from cautious optimism to escalating nervousness. The deterioration in European growth is exactly what German Finance Minister Schaeuble and ECB member Mersch warned about yesterday – the calm in Europe is only an illusion.

European Central Bank President Draghi also spoke this morning where he said the euro-area economy will remain weak in the near term because unfortunately rate cuts weren’t passed on in some countries. He defended OMT by saying that it was essential and doesn’t compromise the ECB’s independence, create excessive risks for taxpayers or lead to inflation. In fact, Draghi indicated that falling prices is currently a bigger risk than inflation, a sign that he is committed to easier monetary policy.

What to Expect from the Fed

Two central banks have monetary policy announcements today starting with the Federal Reserve and followed up by the Reserve Bank of New Zealand. Neither central bank are expected to change interest rates but their guidance will be important. Having just announced a third round of Quantitative Easing last month, we do not anticipate any further stimulus from the U.S. central bank. However we will be looking to see whether the Fed acknowledges the recent improvements in U.S. data including this morning’s rebound in new home sales. Low interest rates continue to provide underlying support for the housing market, helping to increase sales of new homes by 5.7%. Although inventory is still being moved at lower prices, sales rose to their highest levels in 2 years. If the Fed sounds encouraged by recent data stocks could extend their gains, helping to ease safe haven flows out of the U.S. dollar and Japanese Yen. If they err on the side of caution and express skepticism about how long the improvements will last, the sell-off in equities and currencies could deepen.

What to Expect from RBNZ

As for the RBNZ, this will be the very first monetary policy meeting led by Graeme Wheeler. He has not given any major speeches so we do not know much about his monetary policy stance. This will be his first opportunity to share his views and NZD traders will be listening in carefully. We know that a few weeks ago he signed a new policy target agreement that put a more explicit focus on the 2% midpoint, which suggests that he will be tough on inflation. However with CPI growth dropping to its lowest levels since 1999 and exporters calling for the central bank to take steps to fight a rising currency, Wheeler could sound cautious and perhaps even dovish which would be negative for the NZD.

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