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It has been a topsy-turvy morning in the foreign exchange market with the euro on a roller-coaster ride throughout ECB President Trichet's press conference.  As usual, the European Central Bank kept interest rates unchanged at 1.00 percent, leaving the market to focus on the comments from the head of the central bank.

 

At first, the euro came under selling pressure when Trichet talked about how the central bank intends to maintain an easy monetary policy but gained momentum when he announced a significant upgrade to their 2010 and 2011 GDP forecasts along with a mild upgrade to the inflation forecasts.  Trichet also said that the risk to inflation is to upside.  However EUR/USD sold off once again when Trichet said their decision to set the fixed rate based upon the MRO rate is not a signal of a potential rise in rates. Eventually the euro stabilized as Trichet wound down his press conference and investors realized that he did not say anything particularly damaging to the euro.

In general, the message from the ECB is that they maintain an easy monetary policy, have no intention to raise interest rates in the near future but will keep withdrawing non-standard measures and long term operations such as the 6 month and 12 month refis as the market continues to normalize. They recognize the improvements in economic data which were stronger than expected and make a double dip recession unlikely but like the Bank of England, they believe the improvements will be temporary.  Although they upgraded their GDP forecasts for 2010 and 2011, the risks to the economic outlook are on the downside due to the emergence of renewed tensions in the financial markets, uncertainty in other markets, the recent increases in oil prices and the risk of a disorderly correction of global imbalances.  Higher energy prices also contributed to their upgraded inflation forecasts and as a result, the ECB remains "cautious and prudent." In general, they expect the economy to grow at a moderate pace and price stability should remain contained.

Yet despite the recent improvements in economic data, the ECB's decision to continue their 3 month refi operations with a full allotment at a rate that is fixed to the average MRO rate and their decision to extend unlimited loan offerings into 2011 indicates that they have not relaxed on monetary policy. They remain vigilant and will continue to do what is necessary to deliver price stability.  On the U.S. economy, he is not "too disappointed" by the developments in the U.S. and shares Bernanke's analysis (in other words pessimistic) outlook on the U.S. economy.  Compared to the Federal Reserve, the ECB's tone was more upbeat and it is clear the central bank is still a step ahead of the Fed when it comes to normalizing monetary policy.  The Fed's last decision represented a step back to monetary easing whereas the ECB continues to move forward by withdrawing emergency measures

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Here are the latest revisions to the ECB's forecasts

GDP

2010 from 0.7% - 1.3% to 1.4% - 1.8% 2011 from 0.2% - 2.2% to 0.5% - 2.3%

Inflation

2010 from 1.4% - 1.6% to 1.5% - 1.7%

2011 from 1.0% - 2.2% to 1.2% -  2.3%

Mixed U.S. Data

The dollar on the other hand is holding steady after this morning's U.S. economic reports.  Jobless claims declined slightly from an upwardly revised 478k to 472k in the week ending on August 28 while continuing claims grew from 4.479M to 4.456M.  Claims are much higher this month than last month which suggests that the improvement in the labor has slowed.  Pending home sales on the other hand rose 5.2 percent in the month of July which is very encouraging after dismal new and existing home sales because it suggests that not all is bad in the housing market. Although factory orders rose 0.1 percent in July, which was slightly weaker than expected, the market is still reeling off of the stronger manufacturing ISM number.     

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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.

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