Assessing The Fed

Last updated 6/23/2010 5:47 PM ET (GMT -5) 2 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• DOLLAR: ASSESSING THE FED
• EUR: PMIs MIXED BUT STILL GROWING
• GBP: MINUTES SHOW BoE DIVIDE
• CAD: RETAIL SALES LOOK DAMAGING
• AUD: GOVERNMENT MAY HAVE A NEW FACE
• NZD: NARROWING DEFICIT ADDS TO GAINS
• JPY: YEN TO BECOME A CONCERN

EXPECTATIONS FOR UPCOMING FED MEETINGS

DOLLAR: ASSESSING THE FED

With the Fed’s statement out of the way, we can now assess the damage. The FOMC’s more dovish tone sent the dollar into a tailspin, declining against all major currencies except for the loonie. The Canadian dollar was the major outlier of the day, hurt by a very disappointing report on Retail Sales. In terms of stocks, the Dow found some solace in the announcement but the conflicting messages of low rates for an extended period and a more downbeat view of the economy made for choppy trading by late-afternoon.

Fed’s Tone Looks More Dovish

With just a few changes in language, the Fed’s statement, which was two-months in the making, managed to convey to markets that rates would remain stationary for a longer period than many were expecting. Of course, the ‘extended period’ clause remained in prominent use by the Fed, a term they have been relying on to establish their stance on rates for more than a year. This month’s statement did include a few changes, most of which pointed toward a worsening environment. The Fed said that “financial conditions have become less supportive of economic growth, largely reflecting developments abroad.” This is compared to their April meeting when they said that conditions were ‘more’ supportive of growth. By recognizing difficulties abroad, the Fed is to some extent acknowledging the fact that the U.S. will see some spillover from the European crisis. The Fed also noted that “housing starts remain at a depressed level,” dropping April’s phrasing that indicated starts ‘edged up’. This is not a surprise considering the latest report on Housing Starts was slightly less than promising, an event that gave way to a string of disappointing housing data including today’s report on New Home Sales. The FOMC did upgrade their language on employment, saying “the labor market is improving gradually;” from “the labor market is beginning to improve.” The Fed made no mention of their extraordinary asset purchasing plans, symbolizing the fact that, while many of their plans have expired, they are in no hurry to sell assets back to the market. For the fourth straight month, Kansas City President Thomas Hoenig cast a dissenting vote to the inclusion of the “extended period’ wording, saying that it reduces the Fed’s flexibility when it comes time to start increasing rates. Overall, while there were not many surprises in the Fed’s statement, it still looked a bit more dovish than the one issued back in April.

New Homes Sales Serves Up Dose of Reality

New Home Sales sent U.S. stock markets off to a rocky start after indicating that sales plummeted by a record 33 percent last month. This truly disturbing figure puts the annual pace of sales at 300,000, indicating that the market is simply too fragile to operate without government assistance. To make matters worse, the Commerce Department had to revise lower last month’s sales data to 446,000 from 504,000. Now that the tax credit to new home buyers has expired, we are in store for a more accurate portrayal of how weak the housing market really is. Tomorrow’s schedule includes the Durable Goods Orders report as well as Initial Jobless Claims. As always, with the jobs market in flux, jobless claims pose a risk to markets and could start filling in the pieces as to where next week’s Nonfarm Payroll report will stand.

EUR: PMIs MIXED BUT STILL GROWING

EUR/USD rallied strongly off of earlier declines, halting a two-day slide. Today’s release of the Purchasing Managers’ Indexes painted a mixed picture of the European economy. Manufacturing was broadly disappointing with the Eurozone as a whole and France reporting that the sector slumped, while Germany remained unchanged. The results are not particularly reassuring for an economy that has been driven mostly by the export growth that was afforded by the sinking euro. With demand likely to moderate overseas and the euro posting at least a near-term turn around, it is questionable how long exports will be able to come to their rescue. Services, on the other hand, were only a bit stronger, rising in France and staying flat in Germany. Overall, the one promising aspect to note is that both sectors are still comfortably above the 50 threshold that divides expansion and contraction. Markit, the company that produces the report, says today’s results suggests that growth accelerated “perhaps to a robust 0.6% to 0.7% pace" in the second quarter. In a separate report, GFK Consumer Confidence was flat from last month’s 3.5. Even though the report showed no improvement, resilience in confidence will be key components of the region’s ability to weather the storm. Tomorrow’s data schedule brings French Consumer Spending and Total Jobseekers.

GBP: MINUTES SHOW BoE DIVIDE

The pound rose sharply against the dollar after the BoE’s minutes showed that MPC member Andrew Sentance actually opposed the decision to keep rates unchanged. Due to the fact that inflation continues to remain outside of the BoE’s range, Sentance voted to hike by 25bp. His move is a milestone in two respects, first due to the fact that it is the first time the BoE has even hinted at a hike in about two years and second because it was the first time the board had not unanimously agreed on a decision in over one year. Even though the minutes indicated that most members saw conditions “insufficient to warrant a change in stance,” they still noted that the inflationary risk “might necessitate tighter policy.” Before getting too excited about the potential for a BoE hike, one that is so far only supported by one member, we have to account for the fact that this meeting was held before the government announced their emergency budget plan. It would be unlikely at this stage in the game that the BoE would tighten at the same time the government was imposing large tax hikes and deep spending cuts. The potential side effects on the recovery would be too large to warrant such a decision. Also, it is likely that the bank would announce plans for how to dispose of the £200 billion in bond purchases before they move to change rates. In terms of the budget, the U.K. received yet another vow of confidence from Moody’s who noted that the plan was “supportive” of their pristine credit rating. Moody’s followed Fitch in endorsing the plan, but still said that they expect a “strong negative impact” on consumer spending.

CAD: RETAIL SALES LOOK DAMAGING

USD/CAD skyrocketed by the biggest margin in 3 weeks on a lethal dose of bad data and weak commodities. Surprisingly, the aussie and the kiwi even managed to buck the trend and head for gains. The loonie’s plight today was driven by a nasty retail sales report that managed to shake optimism about the nation’s stellar performance so far this year. Sales plummeted by 2.0%, five-times worse than forecast and the biggest drop since late-2008. With employment still relatively strong it seems that the disappointment is the result of waning sentiment, mostly attributable to growing uncertainties overseas. In Australia, we learned that Prime Minister Kevin Rudd is facing a potential ousting on growing dissatisfaction within his own party. Rudd’s approval has been on downward course ever since he proposed a 40 percent tax on mining profits, leaving his party scrambling to secure their seats at an upcoming election. While political skirmishes typically have large implications for a nation’s currency, traders are not too perturbed due to the fact that Rudd’s potential replacement is unlikely to deviate on policies too much. The kiwi’s gains came mostly on a report that showed the nation’s current account deficit narrowed for the fifth straight quarter, to the least in over two decades. Their GDP report will paint a more complete picture of the country’s health tonight.

JPY: YEN TO BECOME A CONCERN

USD/JPY fell sharply for the second day, enough to reach a new monthly low. The rise in the yen is an uncanny indication of continued worries, but in an even more telling sign of investor fears yields on Japanese 10-year bonds fell to the lowest level since late-2008. Now that the government seems well on its way to invoking a harsh set of new fiscal austerity measures, the persistent strength in the yen may become more burdensome than usual. With consumption taxes likely to double, the Japanese economy will have to continue to count on exports to drive growth, a situation that is unlikely to take shape if the yen appreciates further. In fact, further strains on domestic demand may be realized as Finance Minister Noda indicated that the government may consider expanding their plans to increasing income taxes on high-income earners. Noda indicated that "Japan's position is to try to achieve both economic growth and fiscal reforms," a position that is likely to be argued at this weekend’s G-20 meeting. With concern over the yen mounting, tonight’s release of the Merchandise Trade Balance becomes even more important in assessing how quickly the government will have to respond.

EUR/USD: Currency in Play for Next 24 Hours

EUR/USD will be the currency pair in play for the upcoming 24 hours. The Euro-Zone is set to release French Consumer Spending figures at 2:45 ET or 6:45 GMT and Industrial New Orders at 5:00 ET or 9:00 GMT. In the United States, Core Durable Goods Orders for the month of May and Unemployment Claims figures will be released at 8:30 ET or 12:30 GMT.

The pair is currently trading within our Range Trading Zone, established through the Bollinger Bands. The pair appears to be battling the major downtrend but is seemingly failing in its efforts to do so. The support which proved to be sufficient this past week is placed at 1.2144, which is the previous month’s low. If this level is broken, the next significant support level is at the Four-Year Low of 1.1876, which was hit earlier this month. On the other hand, strong resistance is at 1.2455, a level which provided strong support for the pair back in late 2008 and early 2009.

Comments (2)

true man

June 23, 2010 at 09:08 PM ET

From Exceptional loose to Sustainable loose

FOMC should change her tone from " exceptional loose " to "sustainable loose" since 2010-03-16 meeting. Change the FF Rate range from " 00-25 " to "00-50" since 2010-04-28 meeting. Focus on new situation measuring since this meeting.

As long as employment has no basic progress , FOMC really should keep loose policy . But this should not mean money-game can take this loose as juicy windfall. Up to now, tendency is clear and clear : whenever economy has chance to progress, money-game always be the first one to catch and the only one to eat up the chance.

FOMC should quit exceptional loose as soon as possible . This is nothing to do with inflation but to the disaster -- prize to money-game, punish to other -- hid within the exceptional loose.

Mr. Hoenig is more correct than others.

jet

June 24, 2010 at 12:19 AM ET

AMEN - well said true man

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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.