Dollar Dumped Amid Specualtion of Fed August Pause

The dollar fell across the board amid escalating speculation of an August Fed hike as traders increasingly expect that rising evidence of a slowing US economy will shadow the Fed’s anti-inflationary concerns. Although the US core PCE price index came in at 2.1% in May--above the Fed’s comfort level of 2.0%, the accompanying data showing a slowdown in personal spending and incomes added to the downward pressure on the greenback. Consumer spending grew by 0.4% in May after an upward revision to 0.7% from 0.6% in April, while personal income increased by 0.4% in May following a 0.7% rise in April.


The University of Michigan’s consumer sentiment survey rose to 84.9 in June from May’s 79.1, but it failed in stabilizing selling pressure on the dollar. Further selling ensued when the National Association of Purchasing Management Chicago index fell to a 4-month low of 56.5 in June after May’s 61.5 in May.



Rumors that Washington Consultancy Medley Advisors indicated today that Fed will pause in August helped accelerate the dollar’s downfall. A Reuters poll of 20 primary Treasury dealers found that 10 dealers expected the Fed to leave the fed funds rate unchanged at 5.25%. Gold prices jumped by nearly $20 per ounce to $613.00/oz, the highest in 2 ½ weeks.



Euro hits 3-week highs on talk of Fed pause



EURUSD rallied by more than 1.5 cents to 1.2794 as the dollar sustained a fresh selling wave, this time on weak US reports on income and spending. We noted that the key question to be raised is whether the increased signs of slowdown will catch up with inflationary pressures to the extent of clouding the visibility for the market regarding the August 8 decision. We think that emerging signs of a slowdown in the housing market (mortgage applications at 4 year lows, year-on-year existing and new home sales have posted 6 and 5 consecutive monthly declines respectively—the longest losing streak since 1995) will increase the odds for a rate pause in August, which should instill further stability in the euro and the yen.



The chart above shows that the EURUSD chart –and dollar charts in general have sustained 2 major turning points; June 5—when Fed Chairman Bernanke made a clearly anti-inflation speech, boosting the dollar across the board; and June 29—yesterday’s FOMC meeting, which sounded a more explicit with slowing growth. Breaching above the 1.2750 level, EURUSD will test the 1.2825-30 territory. Any figure below 55 in Monday’s release of the manufacturing ISM, should fuel the euro past the 1.2820s. Also of importance is Monday’s release of the Eurozone PMI.







Dollar weakness overwhelms Fukui Concerns

Thursday’s FOMC statement helped drag USDJPY from its 116.50 perch, breaching the 6-week trend line support of 115.00 and onto 114.20. Monday’s release of the tankan survey should further speculation of a BoJ rate hike on July 13-14. Yet despite the re-emerging bearishness in USDJPY, traders must remain alert to renewed demands of Fukui’s resignation. We see upside remaining limited at the 100 day MA of 115.50, while support standing at 114, backed by key foundation of 113.80.

At 2:00 AM Germany May Retail Sales (exp -0.3%, prev 2.8%) At 4:30 AM UK Q1 GDP q/q (exp 0.6%, prev 0.6%) UK Q1 GDP y/y (exp 2.2%, prev 1.8%) At 5:00 AM E-12 June CPI y/y (2.4%, prev 2.5%) E-12 June Business Climate Indicator (exp 1.01, prev 1.06) E-12 June Industrial Confidence (exp 1, prev 2) E-12 June Consumer Confidence (exp -9, prev -9) E-12 June Economic Confidence (exp 106.3, prev 106.7) At 5:30 AM UK June GfK Consumer Confidence Survey At 8:30 AM US May Personal Income (exp 0.2%, prev 0.5%) US May Core PCE Price Index (exp 2.1%, prev 2.1%) US May Personal Spending (exp 0.4%, prev 0.6%) At 10:00 AM US June Chicago PMI (exp 59.0, prev 61.5) US June University of Michigan Sentiment (exp 82.5, prev 82.4)

The dollar extended yesterday’s losses versus the majors in early Friday trading, tumbling beneath the 1.27-level and below the 115-handle against the yen. The FOMC lifted rates by 25-bp to 5.25% when it announced its decision yesterday afternoon. However, markets sold off the dollar as a result of the accompanying Fed statement, which was interpreted to have a more dovish tone. The Fed acknowledged moderating economic growth in the US, but also noted that inflation expectations remained contained. Accordingly, on the anticipation the Fed tightening may pause in August, traders pushed the greenback lower to 3-wks low versus the euro.

Several key US economic reports are due out for the coming session beginning at 8:30 AM EST. The May core PCE price index is forecasted to remain unchanged from April at 2.1%. A softer than anticipated inflation figure will further fuel sentiment in favor of an August pause by the FOMC, thereby pressuring the dollar lower. On the flipside, a much stronger than expected reading may provide a floor for the currency and thwart off additional selling. May personal income is forecasted to decline to 0.2%, down from 0.5% in April, while personal spending is also seen lower at 0.4%, versus 0.6% previously. At 10:00 AM, June Chicago PMI will be released, forecasted to drop to 59.0, down from 61.5 in the prior month. Also due out in the same time slot will be June University of Michigan sentiment survey, seen improving marginally to 82.5.

Euro Buoyed Near Multi-Week High

The euro was rewarded to its highest levels since early June as a result of the broadbased dollar decline that ensued following the FOMC statement. Traders will look ahead to Eurozone confidence surveys at 5:00 AM EST and June Eurozone annual CPI. The consumer price index in June is expected to decline marginally from the previous year at 2.4%, down slightly from 2.5%.

The euro’s gains stalled just shy of the 50% retracement of the drop from 1.2979 to 1.2476 at 1.2725. Gains will target resistance at 1.2785 – the 61.8% retracement of the aforementioned decline, backed by 1.2840 and 1.2870. Subsequent ceilings are eyed at 1.29, followed by 1.2940 and the multi-month high of 1.2980. Support begins at 1.27, followed by 1.2670 and 1.2640. Additional floors will emerge at 1.26, followed by 1.2560 and 1.2520.

Mixed Data Keeps USDJPY near Lows

A barrage of economic data was released from Japan earlier in the session, with a mixed set of results keeping dollar/yen in range near its lows. Manufacturing PMI dropped to its lowest level in 10 months to 54.3 in June, down from 55.3 a month earlier. The export orders component fell to 50.3, its lowest level in 18-months versus 51.8. The May adjusted unemployment rate beat expectations, slipping to 4.0% versus calls for an unchanged reading of 4.1%. Meanwhile, the May wage earner household spending dropped to 2.7% worse than both the 2.3% decline expected and the previous 2.0% drop.

More notably, with BoJ members emphasizing the importance of upcoming data on Bank policy decisions, inflation reports have been closely scrutinized. The May nationwide core CPI report was inline with forecasts at 0.6%, unchanged from the previous month. The headline report marginally exceeded forecasts, but held steady from the April up 0.6% also.

Japan’s Finance Minister Tanigaki expressed his desire for the BoJ to ensure the economy exits from deflation and does not relapse. While he sees deflation improving quite a bit, he does not think it is over yet and as such, he believes monetary policy needs to support the economy while mired in deflation. With respect to foreign exchange moves, Tanigaki attributed interest rate differentials as one governing factor.

USDJPY trades just beneath the 115-handle, with support starts at 114.50, followed by 114 and 113.65. Additional floors are seen at 113.30, backed by 113 and 112.70. Interim resistance starts at 115.20, followed by 115.50 and 115.80. Additional ceilings will emerge at 116, backed by 116.40 and 116.75.

The Fed raised its fed funds rate by 25 bps to 5.25%, the highest level since March 2001, maintaining the door open for the possibility of further rate hikes, while sounding more certain regarding slowing activity without upgrading the risks to inflation .

Regarding inflation, the Fed maintained its description of inflation expectations as “remain contained”, while the impact of resource utilization and rising energy prices to continue to only: “have the potential to sustain inflation pressures.”

Regarding growth, the statement made a subtle transition into recognizing the slowdown in growth.

In May 10, the statement noted: “The Committee sees growth as likely to moderate to a more sustainable pace, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.”

Today, the Committee noted: “...indicators suggest that economic growth is moderating from its quite strong pace earlier this year, partly reflecting a gradual cooling of the housing market and the lagged effects of increases in interest rates and energy prices.

FX Reaction: The dollar is falling across the board as the Fed issued a more certain note towards moderating activity, while making no upgrade in its inflation vigilance. This is clearly seen in the disappearing inversion in the yield curve as the yields on 10 and 2 year treasuries are now equal at 5.20%, which is a negative for the US dollar . See chart.



We noted in our morning note, “we expect the dollar to sustain brief losses as a knee-jerk reaction to the less aggressive rate hike, rather than 50 bps as some players may have feared or expected.”

Fed Depends on Data & Markets Depend on Fed

In the incoming 5 weeks leading up to the August 8th FOMC decision, the Fed will revert to data dependence while markets will shift to Fed dependence. The absence of a scheduled FOMC meeting in July will be replaced by the release of: 1) today's FOMC meeting (due tentatively on July 18/19) and; 2) Bernanke’s semi-annual testimony to Congress (tentatively on the week of July 17), both of which should serve as a much needed anchor for steering market expectations.

In the 6 weeks period leading to today’s FOMC decision, markets had clear visibility about the outcome of today’s meeting thanks to widely unequivocally hawkish minutes of the May 10 FOMC meeting, Bernanke's description of the latest inflation data as "unwelcome" and 3) concerted anti-inflation speeches from Fed officials.

Going forward, the key question going to be raised is whether the increased signs of slowdown will catch up with inflationary pressures to the extent of clouding the visibility for the market regarding the August 8 decision. We think that emerging signs of a slowdown in the housing market (mortgage applications at 4 year lows, year-on-year existing and new home sales have posted 6 and 5 consecutive monthly declines respectively—the longest losing streak since 1995) will increase the odds for a rate pause in August, which should instill stability in the euro and the yen.

3:55 am GER June Unemployment Rate (exp11.0%, prev 11.0%) GER June Change in Unemployment (exp -30K, prev -93K) 4:00 am E-12 May M3 Money Supply Growth y/y (exp 8.8%, prev 8.8%) 8:30 am US Q1 GDP – Final (exp 5.6%, prev 5.3%) 8:30 am US Weekly Jobless Claims (exp 305K, prev 308K) 8:30 am CAN April Real GDP (exp 0.1%, prev 0.1%) 12:40 pm CAN Bank of Canada Sr Deputy Gov Jenkins Speaks. 2:15 pm US FOMC Interest Rate Announcement (exp 5.25%, prev 5.00%)

We expect the Fed to stick to its modus operandi in terms of action and rhetoric, raising the Fed funds rates by 25 bps to 5.25% and keeping the door open for further tightening ahead, as conditioned by its dependence on the incoming data.

Aside from the magnitude of the rate hike, the 3 factors at the top of the list of traders’ radar screen in today’s FOMC statement will be:

1. Rhetorical balance between the positives of economic growth and signs of slowdown (2nd paragraph of statement)

2. Extent of inflation assessment. Will energy prices impact continue to be described as “modest” and will inflationary pressures still be referred to as “potential”? (3rd paragraph of statement)

3. Phrase indicating possibility of “further policy firming” (4th paragraph)
In addition to maintaining inflation vigilance and allowing possibility for “further policy firming”, the Fed is likely to be more cognizant of the slowing economy. The insistence on further data watch should be of no surprise.

Nevertheless, recurring inflationary expectations, coupled with the bounce in oil above $71 per barrel should maintain the FOMC’s inflation vigilance and keep the phrase indicating: "some further policy firming may be needed".


Today’s much anticipated FOMC decision will prove more anticlimactic than was previously
thought a month ago due to the following reasons:

1. The widely hawkish minutes of the May 10 FOMC meeting (released on May 31), Bernanke’s June 5th speech describing 3-month and 6-month inflation as “unwelcome developments” and the consistently hawkish speeches by each Fed official last month sealed the deal for a June rate hike.

2. Any doubts that the tightening cycle would end this summer due to evident signs of an economic slowdown have been dispelled by a set of data releases that did not convey sufficient urgency to shadow the Fed’s immediate battle on inflation.

The absence of a scheduled FOMC meeting in July will be replaced by the release of today’s FOMC meeting (due tentatively on July 18/19) and the Fed’s semi-annual testimony to Congress (tentatively on week of July 17), both of which should serve as the much needed anchor for steering market expectations.

Should the aforementioned forecast prove correct, we expect the dollar to sustain brief losses as a knee-jerk reaction to the less aggressive rate hike, rather than 50 bps as some players may have feared or expected. Although a 50 bps tightening is expected by a negligible minority in the market, the justification of such a policy decision is not unwarranted. But we expect expectations for further tightening ahead combined with the return to data-dependence mode may retain the upward bias in the US currency.

Yen pressured as calls for Fukui’s resignation escalate

Continued public demands for Bank of Japan Gov Hayami to resign following his investment in the scandal-ridden Murakami fund have escalated to a new level. This time, senior LDP official Kozo Yamamoto said governor Fukui should quit immediately in an open letter of "personal opinion". This is the first direct call for Fukui’s resignation by a lawmaker from PM Koizumi's ruling party. Koizumi, has repeatedly voiced support for the embattled Fukui, who has been credited with instilling stability in Japanese financial markets and the economy after his appointment in early 2003.

Market consensus is now shifting towards a possible Fukui resignation once the central bank implements the much anticipated lifting of its zero interest rate policy, most likely to take place in mid July. Despite Fukui repeated apologies for the scandal and his plan to return 30% of his monthly salary for the next 6 months, 67% of those polled by the Asahi Shimbun newspaper said Fukui should resign for his controversial investment.

The affair is eclipsing increased speculation of BoJ rate hike in 2 week’s time, perhaps to the benefit of the Japanese politicians who prefer a relatively weaker currency. Interestingly, any remarks about the economy, monetary policy or currency by Gov Fukui may lose their effect as long as calls for Fukui’s resignation remain in the spotlight.



Lingering negative sentiment surrounding Fukui and expectations of further Fed hikes are pushing the dollar towards the key resistance of116.67 yen—the 61.8% retracement of the 1213.6-108.97 move. We do not rule out breach to extend the pair into the subsequent target of 117.20—trend line resistance extending from the 121.36 December high. Interim support stands at 115.80 , followed by subsequent foundation at 115.50--the 100 day MA. Key support stands at 115.20.

Euro downside risk ahead

Highlighting the EURSD’s tepid reaction to the unexpected rise in German IFO survey reflects shaky sentiment in the single currency against the dollar in light of the FOMC decision. With the Fed firmly expected to raise rates by at least 25 bps in the next 2 months and the US data showing no urgent signs of any disconcerting slowdown, traders are allowing the possibility for a faster increase in the US-EUR yield differential. While there is talk of an ECB rate hike in August, there’s no such speculation for July. But the release of the minutes of today’s meeting and Bernanke’s semi annual Congressional testimony both due in mid July should steer expectations towards further tightening.

Downside risk on EURUSD remains shaped by the prospect of a hawkish FOMC statement, that will leave the door open for an August rate hike. Thus, we could see the pair testing the 1.24 figure next month, but more stability should be expected as we approach the August 8 meeting. We do not expect the Fed to deliver an inter-meeting rate hike in July, for the sole reason that such a surprise would trigger a fresh wave of selling in capital markets. Although there’s chatter of an ECB rate hike in August 31, the July 6 meeting is deemed too early for pricing a move.

We see interim support tested at 1.2515-20, followed by 1.2470-75 in the event of tough Fed inflation talk. Only escalating hawkishness from ECB would prevent EURUSD from testing 1.2450 in next two weeks. Upside continues to face pressure at 1.2600, followed by 1.2630s.

The dollar was slightly higher versus the majors in Wednesday trading but remained confined within narrow ranges ahead of tomorrow’s FOMC monetary policy meeting. The greenback continues to trade near 116.40 versus the yen and 1.2540 to the euro. The primary event will be Thursday’s policy announcement slated for 2:15 PM EST, in which markets are expecting a 25-basis point rate hike to 5.25%. With a quarter point hike fully priced in, the possibility for either a surprise 50-bp hike or an FOMC statement that highlights further concern over inflationary pressures in the economy will be a shot in the arm for the dollar.

In addition to the FOMC rate decision, traders will also closely scrutinize US economic reports slated for release in the morning. The data include Q1 GDP, Q1 personal consumption, Q1 core PCE and weekly jobless claims. Consensus forecast for Q1 GDP is an increase to 5.6% from the previous year’s growth rate of 5.3%. Weekly jobless claims are seen little changed from the previous week, down slightly to 305k from 308k.

Incoming US Treasury Secretary Henry Paulson, speaking to Congress, said his objective would be for an openly traded Chinese currency and wants the yuan’s value to be dictated by market forces. Paulson said he’ll press China to do more to boost domestic demand rather than rely on exports. He believes the US current account deficit is a global issue, instead of merely being a domestic matter and as such, a global strategy is needed to address it. Paulson expressed concerns about US saving, structural reform in Japan and Europe, and currency flexibility in Asia.

Euro Slides Lower Ahead of Data

Although all attention will focus on the FOMC decision, Eurozone economic data to be released on Thursday will also be closely watched. The reports consist of Germany’s June labor report and May Eurozone M3 money supply. Germany’s seasonally adjusted unemployment rate in June is seen unchanged from May at 11.0%, while the unemployment change is expected to drop 30k from a 93k decline previously. Eurozone M3 money supply is also seen unchanged from previously at 8.8%.

The euro continues to drift lower, consolidating between 1.2560 and 1.2540. Support is eyed at 1.2530, followed by 1.25 and 1.2460. Additional floors are eyed at 1.2420, backed by 1.24 and 1.2370. Gains will target interim resistance at 1.26, followed by 1.2640 and 1.27. Subsequent ceilings are seen at 1.2750, followed by 1.28 and 1.2850.

Yen Remains Soft

Dollar/yen consolidates above the 116-level with traders sidelined ahead of tomorrow’s main event. Resistance starts at 116.70 and 117. Additional ceilings will emerge at 117.30, backed by 117.80 and 118. Interim support starts at 116, backed by 115.70 and 115.40. Subsequent ceiling will encounter floors at 115, followed by 114.60 and 114.20.

Resistance is seen at 146.65, followed by 147 and 147.50. Additional resistance is seen at 147.80, backed by 148 and 148.50. Support starts at 146, backed by 145.80 and 145.30. Subsequent floors are seen at 145, backed by 144.60 and 144.20.

No Key Economic Data

The currency market continued to consolidate, with the major pairs trading in recent ranges. The Wednesday session is expected to remain quiet given the dearth of economic data. The FOMC kicks off its two-day monetary policy meeting today, and will announce its decision on Thursday at 2:15 PM EST. Economists expect the FOMC to raise its benchmark lending rate by 25-bp, with some aggressive estimates calling for a 50-bp hike. With a surprise 50-bp interest rate hike, the dollar will receive a shot in the arm against the majors.

USDJPY

Japan PM Koizumi reiterated his support for BoJ Governor Fukui, saying there was no reason for the embattled governor to resign from the post. Nevertheless, overwhelming public sentiment in Japan wants Fukui to step down from his responsibilities.

Dollar/yen consolidates above the 116-level with traders sidelined ahead of this week’s main event. Resistance starts at 116.45, followed by 116.70 and 117. Additional ceilings will emerge at 117.30, backed by 117.80 and 118. Interim support starts at 116, backed by 115.70 and 115.40. Subsequent ceiling will encounter floors at 115, followed by 114.60 and 114.20.

The euro remains afloat versus the yen, propped near its all-time highs above the 146-level. Resistance is seen at 146.65, followed by 147 and 147.50. Additional resistance is seen at 147.80, backed by 148 and 148.50. Support starts at 146, backed by 145.80 and 145.30. Subsequent floors are seen at 145, backed by 144.60 and 144.20.
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EURUSD

With little Eurozone economic data slated for release in the coming session, traders will focus on speeches from ECB officials. ECB board member Garganas will speak at the Economic Conference in Athens at 2:10 AM EST, while Mersch will speak in Luxembourg at 9:00 AM EST.

The euro traded beneath the 1.26-level in the early Asian session. Support is eyed at 1.2550, followed by 1.25 and 1.2460. Additional floors are eyed at 1.2420, backed by 1.24 and 1.2370. Gains will target interim resistance at 1.26, followed by 1.2640 and 1.27. Subsequent ceilings are seen at 1.2750, followed by 1.28 and 1.2850.