There are a number of U.S. economic reports scheduled for release today but the primary driver of dollar flows continues to be the FOMC minutes. The Fed is getting more serious about phasing out asset purchases and this has led many traders to reverse their short dollar positions. Yet while the greenback extended higher against the euro today, it gave up some gains against the British pound and Japanese Yen. This lack of follow through in other pairs may reflect some skepticism about timing. According to the FOMC minutes, the central bank will reevaluate its asset purchases next month but they may not choose to taper their purchases until later in the year. The slow pace of recovery in the U.S. economy and lack of significant inflationary pressures gives the Fed the flexibility to keep monetary policy easy if they so desired.

This morning’s CPI report showed consumer prices stagnating in the month of January and growing a mere 0.3% ex food and energy, driving annualized CPI growth down to its lowest level in 6 months. Jobless claims rebounded to 362k from 341k and while the data is still being distorted by estimates, it is nonetheless consistent with a slow recovery in the labor market. Existing home sales and the Philadelphia Fed index will be released later this morning but we don’t expect these reports to shift the outlook for the dollar significantly. The sharp improvement in manufacturing conditions in the NY region points to the possibility of a similar uptick in manufacturing conditions in Philadelphia, which would be positive for the greenback. Our main focus will be on comments from Fed President Bullard this afternoon. Three Fed Presidents are scheduled to speak today but Bullard is the only FOMC voter. Right now, investors will be looking to upcoming speeches by U.S. policymakers including Bernanke next week for affirmation of the Fed’s new bias.

Between the FOMC minutes and this morning’s weaker Eurozone PMI numbers, the euro has been pushed to a 1 month low against the U.S. dollar. While the currency pair has rebounded since then, both the European Commission’s forecasts and the Italian elections pose an ongoing threat to the euro:

European Commission’s Growth and Deficit Forecasts Pose Risk to Euro

One of the most important comments last week came from the head of European Sovereign Ratings at S&P. Moritz Kraemer warned that Spain, France, Italy and Portugal are at risk of being downgraded this year. If this week’s economic reports and European Commission’s growth forecasts suggests that this risk has increased, then the euro could be in big trouble. The decline in Eurozone GDP growth in the fourth quarter raised concerns that the complete lack of growth last year and the prospect of a flat first quarter will make budget deficits in the region even more unsustainable. Therefore the European Commission’s growth, unemployment and deficit forecasts will be extremely important. While its possible that the EC will look beyond the contraction last year and focus on the signs of growth in the coming year, there could still be concerns about deficits and the currency, especially after today’s weak PMI numbers. Aside from the potential changes to their growth estimates, we will also be looking to see if budget deficit forecasts are increased. If Spain’s budget deficit is expected to exceed 8%, it could also raise the risk of a downgrade for the Eurozone’s fourth largest economy. If the forecasts remain largely unchanged however, it could help the euro.

Italian Election Uncertainty

The election in Italy is also a problem for the euro. The election is being held on February 24th and 25th and between Monti calling Berlusconi a buffoon and Berlusconi slurring in a speech, this will be an interesting one. The leader of Italy’s center left party, Pier Luigi Bersani is neck to neck with former Prime Minister Berlusconi. No one is expected to win a majority and right now, it appears that Bersani is leading slightly in the polls and if he wins he will most likely form a coalition government with Mario Monti’s centrists. This is probably the best case scenario since it would offer assurance of continued reform in Italy. However the elections are close and can still go any way and the worst case for investors and the euro would be a win by Berlusconi because he plans to abolish unpopular property taxes that were the cornerstone of Monti’s austerity measures. A return to the free spending days of Berlusconi would be a big hit to confidence and would increase the risks of a downgrade for Italy and along these lines, the uncertainty surrounding the Italian elections also poses a risk for the euro.

If the outcome of either one of these events is negative, the euro could resume its slide towards 1.31.

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