Wednesday, January 26, 2011

Dollar and Markets Wait FOMC Report | 26 January 2011

Dollar and Markets Wait FOMC Report | 26 January 2011

After Obama’s State of the Union address, the currency markets have failed to find a common theme and trading remains volatile. EURUSD has bounced around the 1.3660 to 1.3706 range while GBPUSD has been holding slightly above the critical 1.5720 support.

Markets still seem to be digesting the, dismal UK GDP release and Obama’s sudden turn toward fiscal conservatism. In addition, today’s event laden calendar has frozen traders who seem unsure what to do next.

The first issuance of EFSF bonds (EURO Bailout Fund) were in serious demand. Official orders standing at €44.5 billion received vs. €5 billion offered.
On one hand it illustrates the confidence investors have in the EU. Also, to receive a decent yield over German bunds (triple-A rated paper) is just to a good deal to pass up.
Who would not take advantage of this trade?

Now moving on to news out of the United Kingdom. The latest GDP number printed a dire picture, coming in at -0.5% q/q vs. the 0.5% that was expected. Not to continue and push a point here but, the GDP data and underlying inputs look as if economic activity in the UK is slowing significantly.

From a fundamental viewpoint we suspect weather in England was even more then -0.5 erosion attributed and we should see this reflected with decent recovery in Q1 2011. But then, weather related events are tricky to forecast and predict.

That said the technical analysis is cloudy with a skew further towards a possible downside trend. The soft numbers combined with BoE Governor King’s reiteration that the Bank of England remains steadfastly committed to low policy rates, has reignited opinion that the next hike will not come till Q4 2011.

However, we suspect that today’s BoE meeting will bring out the hawkish side of members who want to fight inflation (England is also trying to fight a surging inflation).
Now turning to today’s the highlight out of the US, the Federal Open Market Committee meeting.

Markets are clearly focused on the accompanying statement. It is universally expected that monetary policy rate & the asset purchase program, better known as quantitative easing or QE2, will remained unchanged.

While investors expect the language referring to potential duration of the FRB’s ultra loose monetary policy will remain untouched and the current program of QE2 purchases ($600bn) to be completed as scheduled, language suggesting different can drive the markets. Looking at the last FOMC meeting, officials felt “that the change in the outlook was not sufficient to warrant any adjustments to [QE2],” and some noted that “more time was needed to accumulate information on the economy before considering any adjustment."

Given recent improvement in growth (including this week’s GDP expected to hit 3.5% Q4), a fall in unemployment rate and a rise in inflation data has potentially increased the likelihood that new language will be introduced. The FRB might begin to acknowledge the momentum in the US economy.

However, should the FOMC show no near term sign of concession, this will reinforce the markets view that the EURUSD interest rate divide will continue to widen, making the USD negative. All this… and we and the markets wait.

January 26, 2010 - by David Frank, Financial Analyst, Ava Fx