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USD: Will Fed Ease Before ECB?

Kathy Lien, Director of Currency Research, GFT





  06/20 Meeting 08/01 Meeting
NO CHANGE 62.0% 61.5%
CUT TO 0.00% 38.0% 37.3%
HIKE TO 0.50% 0.0% 1.2%



The promise of more stimulus from central banks boosted currencies and equities around the world. While the European Central Bank left interest rates unchanged, they paved the way for more easing in July. Comments from Federal Reserve officials also suggest that the Fed is warming to the idea of introducing another round of Quantitative Easing. Despite the recent stability in the financial markets, the outlook for global growth deteriorated significantly and the only reason why currencies and equities stabilized is because investors hope that European leaders will make a major announcement quickly. Many challenges need to be overcome before this can happen and negotiations can break down at anytime because at the end of the day, European nations are being asked to bear more pain in the near term. More importantly however, the fact that the ECB stood pat today means there is a realistic possibility that the Fed could ease before the ECB.

According to Fed President Lockhart, who is a voting member of the FOMC this year, "extending operation twist is on the table" and according to Fed President Williams, who is also a voter, the Fed must “stand ready to do more” if needed. The most important event risk tomorrow will be Fed Chairman Ben Bernanke’s testimony on the outlook for the U.S. economy. He has been laying low for the past few weeks but when the Fed last met in April, he said they were prepared to take more balance sheet actions if the economic outlook worsened. This was a major surprise at the time because the central bank raised their inflation forecast and lowered their unemployment rate projections, creating a great deal of confusion in the markets. Since then, his pessimistic view has been validated and so at bare minimum, he will eloquently say “I told you so.” The sharp deterioration in the labor market will only increase his concerns for the U.S. economy and this sentiment will most likely be shared in his speech on Thursday. If Bernanke verifies this possibility, we could see further weakness in the U.S. dollar as traders continue to adjust their near term rate hike expectations. However it will be a close call.  Like in Europe, if it was up to economic data alone, the Fed would boost asset purchases immediately but timing is critical right now and the Fed meeting comes on the heels of the G20.

Meanwhile the results of the Beige Book were mixed. The report concluded that the economy expanded at a moderate pace last month which is at odds with recent economic reports. The reviews from the individual districts range from a slow pace to steady growth of economic expansion.  The manufacturing sector saw signs of improvements in most Districts with energy production and exploration improved except for coal which reported a slight decline in activity. Demand appeared to be the strongest in auto and steel manufacturing although hiring was a different case because some Districts reported difficulty in finding qualified workers. Retail spending ranged from flat to modestly positive as there were a few reports that high fuel prices distressed consumer spending and sentiment. New vehicle sales and travel and tourism remained strong. Real estate improved since the previous report as new home construction, commercial real estate conditions increased although it is to note that home prices remained unchanged but sellers were lowering asking prices.  At the end of the day, Bernanke’s stance is the most important and we will get fresh details on that tomorrow. 


The euro ended the day higher against the U.S. dollar after selling off initially following ECB President Mario Draghi’s press conference. The promise of more stimulus and a way out of the crisis overshadowed the possibility of an interest rate cut next month. According to Draghi, the central bank is watching data closely and stands ready to act if necessary.  As expected, the European Central Bank left monetary policy unchanged and laid the groundwork for a move in July.  Based upon Draghi's concerns about economic growth and the increased risks to the downside for the Eurozone economy, they have every intention to ease.  In fact, Draghi even admitted that "a few council members would have preferred a rate cut today."  The only reason why they passed was because Draghi believes that monetary policy "can't fill lack of action" by European governments. Even though he said it is not the ECB's job to push governments into action, there is no question that its their strategy.  By holding back stimulus, the ECB is effectively pressuring European governments to be proactive so the ECB can be reactive.  There are plenty of advantages to waiting until July.  By then, they would know the outcome of the Greek elections, see the IMF's assessment of Spain and the market's response to the G20 meeting.  If things awry, they can always increase liquidity between meetings.  The ECB has quite a bit of tools at their disposal.  They can expand their long term refinancing operation, cut interest rates and / or leave asset purchases unsterilized. Draghi believes that the LTROs have prevented serious disruptions in the financial markets but he is skeptical about the effectiveness of more LTROs which suggests that a rate cut could be the ECB's next move.  While the ECB unveiled their latest GDP and inflation forecasts, investors should take their revisions with a grain of salt because they were finalized before the soft economic reports.  If the ECB incorporated the decline in manufacturing and service sector activity, they would have cut their GDP and inflation forecasts more significantly.  For 2012, they expect growth of -0.5 to 0.3%, which was the same as prior forecasts but 2013 growth was downgraded slightly to 0 - 2.0% from 0 - 2.2%.  Although the central bank believes that inflation will fall below their 2 percent target at the start of next year, they only tightened their inflation forecasts slightly.  In 2012, they see inflation at 2.3-2.5% versus a prior forecast of 2.1 to 2.7%.  Next year, they expect inflation to drop to 1.2-2.2% vs. 0.9-2.3%. Their anticipation of softer inflationary pressures confirms that monetary policy will remain easy through the better part of 2013.


U.K. traders have finally returned to the markets after their 4 day weekend and the rally in risk at the start of the European trading session indicates that rest and relaxation have made them less pessimistic about the outlook for the U.K. economy. This sentiment is important because it provides the benchmark for which the market’s reaction to the Bank of England’s monetary policy announcement will be measured. The British pound traded higher against the U.S. dollar and euro ahead of the rate decision. The BoE is not expected to alter monetary policy this month but like the ECB and the Fed, they will move closer to pulling the trigger on additional stimulus. Consumer spending weakened materially last month while inflationary pressured eased. Manufacturing activity also slowed considerably with the sector contracting at its fastest pace since May 2009. Activity in the construction sector continues to grow but at a slower pace last month. We know that at least 2 members of the monetary policy committee will vote for an increase in asset purchases but there is a reasonable chance that a number of other members will follow. The only question is whether there will be enough of a majority for action this month. If there isn’t the GBP/USD will rally in relief but the devil is in the details of which we will know when the minutes are released a few weeks later. Of course, if they ease, which is not the consensus view the GBP/USD will fall. In addition to the BoE meeting, the U.K.’s service sector PMI report is also scheduled for release.


Thanks to the rally in U.S. equities, the Australian, New Zealand and Canadian dollars ended the day higher against the greenback. Australia was the only country with economic data and according to the latest report, the economy expanded by 1.3 percent in the first quarter, which was two times faster than expectations. Solid consumer demand helped to cushion the economy from weaker growth in Europe and Asia. For the Reserve Bank, interest rate expectations have been pared as a result. Following the quarter point rate cut earlier this week, investors were looking for another half point move in July. With the stronger GDP number, those expectations have been pared. Australian construction sector PMI and employment reports will be released this evening. Based on the sharp decline in the employment component of the manufacturing and service PMI indices, job growth should have slowed. However the pullback may not be that significant considering RBA Governor Stevens’ comment yesterday that “overall labor market conditions firmed a little, notwithstanding job shedding in some industries, and the rate of unemployment remains low.” Canadian IVEY PMI is also on the calendar and a softer read is also anticipated with leading indicators growth holding flat and wholesale sales declining. The recent price action of the Australian, New Zealand and Canadian dollars suggests that they have bottomed but the sustainability of these gains will hinge completely on developments in Europe, leaving that the comm. dollars are the whim of global risk appetite. 


Today is third day in a row that the Japanese yen declined against the major currencies as the rally in equities eases flow into safe haven currencies. The weaker yen lends support to the export market which was lacking when the yen was appreciating at high levels for almost two months. No economic data has been released from the U.K. and after the G7 meeting yesterday, Japanese Finance Minister Jun Azumi told reporters that Japan is prepared to provide support if needed. At 19:50 ET / 23:50 GMT Japan will be releasing its data for Japan buying foreign bonds and stocks and foreigners buying Japanese bonds and stocks. At 22:00 ET / 2:00 GMT Japan will release its data for Tokyo Average Office Vacancies.

GBP/USD: Currency in Play for Next 24 Hours

Our currency pair in play for the next 24 hours will be the GBP/USD. We expect from service PMI from the U.K. at 4:30 ET / 8:30 GMT. At 7:00 ET / 11:00 GMT the Bank of England will meet to discuss its rate decision and asset purchase target. The US starts off with continuing claims and initial jobless claims at 8:30 ET / 12:30 GMT followed by Bernanke’s testimony to the US Congress at 10:00 ET / 14:00 GMT.

GBPUSD is currently trading at a range according to our Double Bollinger Bands. Nearest support is today’s low of 1.5375. Should the pair break below this support then our second support will be at 1.5233 which is the January 12th low and where the lower second standard deviation Bollinger Band lies. On the up side the nearest resistance will be at today’s high of 1.5514 where it touches the 10 day SMA. Should this resistance break then a heavier resistance will be at 1.5725 where the 50% Fibonacci Retracement drawn from the year to date low to year to date high and 200 day SMA touch.