U.S. Dollar: Game Plan For FOMC

Last updated 8/11/2009 5:32 PM ET (GMT -5) 0 Comments - Add your comment

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• U.S. DOLLAR: GAME PLAN FOR FOMC
• EUR/USD: CAUGHT IN A TIGHT RANGE
• GBP/USD: GAME PLAN FOR QUARTERLY INFLATION REPORT
• USD/CAD: HIT BY OIL AND CHINA
• AUD/USD: BUSINESS CONFIDENCE IMPROVES
• NZD/USD: CREDIT CARD SPENDING TURNS POSITIVE
• USD/JPY: BOJ LEAVES RATES UNCHANGED

EXPECTATIONS FOR UPCOMING FED MEETINGS

U.S. DOLLAR: GAME PLAN FOR FOMC

The dollar ended the U.S. trading session virtually unchanged against the Euro and British pound.  This lack of volatility reflects the degree of indecision and uncertainty in the market ahead of the Federal Reserve’s monetary policy announcement.  The biggest question for the market right now is whether or not the U.S. recovery is gaining traction as indicated by the stronger non-farm payrolls report. Unfortunately weaker economic data from China, JPMorgan’s downgrade of MBIA, the world’s largest bond insurer, fears of bankruptcy for CIT and UBS’ downgrade of Yum Brands, has raised justifiable concerns about the outlook for the U.S. economy.  The dollar traded higher against the commodity currencies but lost value against the Japanese Yen and Swiss Franc.  With Fed fund futures pricing in a rate hike as early as the first quarter of next year, there is a lot hinging upon tomorrow’s FOMC announcement.  The latest consolidation suggests that even if the Fed keeps their statement unchanged, there could still be a sharp reaction in the currency market.

Game Plan for FOMC

Based upon the Fed fund futures and the sentiment in the markets, we know that traders are looking for some sign of optimism from the Federal Reserve.  This can come in the form of an upgraded economic assessment, talk of an exit strategy or any other indication that interest rates will not remain low for an extended period of time.  In our opinion, the Federal Reserve will probably retain the tone of the previous statement, mentioning only some of the improvements in the economy and avoid talking about an exit strategy.  You can find more details about this in our FOMC Preview ( Will the Fed Deliver any Surprises ).  However as the U.K. central bank has surprised us with their dovishness while the central banks of Canada and Australia have surprised with their hawkishness, we do not rule out market moving comments from the FOMC.  If the Fed changes or drops their “the pace of economic is slowing” and” economic activity is likely to remain weak for a time,” statements, expect a rally in USD/JPY.  If they talk of exit strategies and bond yields start to rise, we could see a more dramatic dollar rally.  If the Fed disappoints by downplaying the improvements in the U.S. economy, we could see an ugly reversal in the greenback.   The currency pair that will have the purest reaction to the FOMC decision will be USD/JPY.  Although we also believe that the dollar could rally against the euro on the heels of a positive outcome, it is too early to tell if the dollar is trading on fundamentals or risk appetite.  So the best game plan is to focus on USD/JPY.

FOMC Outlook

Economic Data: Review and Preview

This morning’s U.S. economic releases were basically in line with expectations.  Non-farm productivity accelerated in the second quarter but unit labor costs fell much more than expected.  Wholesale inventories also declined but economic optimism improved in August.  None of these reports were market moving.  Before the FOMC rate decision tomorrow, we are expecting the trade balance for the month of June.  The deficit is expected to grow but the sharp improvement in manufacturing ISM suggests otherwise.  If the trade balance shrinks, it could be another reason for traders to buy dollars.  Of course, we would have to see whether the rise was driven by an increase in exports.

EUR/USD: CAUGHT IN A TIGHT RANGE

Last week we witnessed the importance of the 1.45 level for the EUR/USD and this week, we are seeing the significance of 1.40 as support.  The lack of meaningful U.S. and Eurozone economic data kept the currency pair trapped within a 75 pip trading range.  The final figures for German consumer prices and wholesale prices were the only numbers released.  Unsurprisingly, the strength of the euro and weak demand has pressured prices.  For the first time in more than 2 decades, consumer prices declined on an annualized basis.  Typically this would encourage a central bank to lean towards easier monetary policy but this is not true for the European Central Bank whose stubbornness has surprised everyone.  Today’s Financial Times carries an interview with the president of the Federal Association of German Banks.  He warned that Germany could still face a credit crunch in the next few months.  The Eurozone economic calendar remains light on Wednesday.  The only semi-meaningful release will be Eurozone industrial production - weaker activity in France and Germany suggests slower growth for the region as a whole.  

GBP/USD: GAME PLAN FOR QUARTERLY INFLATION REPORT

Even though the British pound was also caught in a tight trading range, unlike the EUR/USD which leaned towards positive territory, the GBP/USD shed a few pips.  U.K. economic data was mixed with the trade deficit ballooning more than expected while house price fell at a slower pace and consumer spending edged higher.  One of the positive aspects of the trade balance report is that the larger deficit was attributed to the strongest rise in imports in close to a year.  Imports and exports both increased in June, a sign that demand is finally recovering.  The British Retail Consortium reported that consumer spending in the month of July increased 1.8 percent.  Sunny weather in the first half of the month helped to drive consumers into the stores for clearance sales while wet weather towards the end of the month boosted furniture and homeware sales. Employment numbers are due for release tomorrow and unfortunately we do not expect a significant pickup in the labor market. If unemployment continues to rise, it may be difficult for the current pace of spending to be sustained.  The Bank of England will also be releasing their Quarterly Inflation report.  After boosting their asset purchase program by GBP50 billion last week, the market will want a more detailed explanation from the central bank.  If the BoE downgrades their growth and inflation forecasts, we could see further weakness in the British pound.  However if they signal that they are now slamming the door shut on further monetary stimulus, we may see a sharp recovery in the currency.

UK Housing

USD/CAD: HIT BY OIL AND CHINA

The Canadian, Australian and New Zealand dollars fell sharply against the U.S. dollar and Japanese Yen.  Their weakness was driven primarily by the disappointing data from China.  With Chinese industrial production rising less than expected and imports falling alongside exports, the general fear is that growth in the Asian Giant is slowing.  If this true, then demand for commodities from Canada, Australia and New Zealand could suffer.  As our colleague Boris Schlossberg pointed out, “Today’s data indicates that the massive fiscal stimulus initiated by Chinese authorities last year may be losing its effectiveness as hyperbolic growth rates begin to slow down. We have long argued that the steroid like infusion of fiscal spending into the Chinese economy was ultimately unsustainable without the pickup in consumer demand from the West. The Chinese economy by itself is simply not large enough to expand at double digit rates fueled by internal demand alone. If the nation’s export demand does not increase materially in the next several months, growth in the economy will hit natural limits which could prove highly negative to risk assets such as the Australian dollar.”  However in the meantime, data from the commodity producing countries are still encouraging.  Credit card spending in New Zealand turned positive last month along with business confidence in Australia.  Australian consumer confidence and the Canadian trade balance are due for release tomorrow.  For the fourth trading day in a row, the Canadian dollar has sold off against the buck.  If the trade deficit grows, we could see further weakness in the loonie.  

USD/JPY: BOJ LEAVES RATES UNCHANGED

The Japanese Yen traded higher against all of the major currencies.  Last night, the Bank of Japan downplayed the promising signs of a steady recovery as concerns about future demand for Japan’s goods remain uncertain. The central bank opted to maintain interest rates at the current level of 0.1 percent, while leaving the assessments for the economy unchanged from its previous meeting. Contrary to the popular conception, the BOJ chose not to mention the future plans for quantitative easing program, leaving investors guessing for the next move. Despite an improvement in exports and production, the central bank fears that demand for goods will halt as companies around the world finish replenishing their inventories. Bank of Japan Governor Masaaki Shirakawa noted that spending by corporations and household remains sluggish. However the latest Consumer Confidence figures, which rose for the 7th straight month, suggest that consumers are more willing to spend. One of important tests of the recovery’s magnitude will come next week when GDP figures are due for release. Many economists predict that the economy expanded by almost 4% thanks to fiscal and monetary stimulus. Later in the evening Domestic CGPI, Industrial Production and Capacity Utilization are due for release. With fears of deflation still roaming, Japanese official will be closely watching Domestic CGPI figures to determine their future policy.

EUR/GBP: Currency in Play for Next 24 Hours

EUR/GBP is the currency in play for the next 24 hours.  The U.K. will be releasing their labor market numbers at 4:30am ET or 8:30 GMT and their Quarterly Inflation Report at 5:30am ET or 9:30 GMT.  Between both of those releases will be the Eurozone industrial production figures which will come out at 5:00am ET or 9:00 GMT. In late June, EUR/GBP established a bottom after a prolonged downtrend. The pair tried to test the lowest level of the year but quickly bounced back, putting the price action into Range Trading Zone which we determine using Bollinger Bands. Despite a quick bounce, EUR/GBP remains in a conundrum. If the pair manages to advance past the 1st Standard Deviation which represents resistance at 0.8625, we can expect a new rally to be established. However, if the pair manages to drift below the 1st Standard Deviation on the downside, it could be posed to test the year to date lows of 0.8525.

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.