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US Dollar, Japanese Yen Down Sharply as Equities Hold on to Gains Post-FOMC Decision

•    Euro Gains on Speculation ECB Will Comment on Exit Strategies for Liquidity Programs on Thursday
•    British Pound Up, Though Uncertainty is Likely to Linger Ahead of BOE’s Rate Decision

US Dollar, Japanese Yen Down Sharply as Equities Hold on to Gains Post-FOMC Decision
The US dollar, Japanese yen, and financial markets in general, experienced wildly choppy price action following the release of the Federal Open Market Committee’s policy statement, in which they announced that they had left the fed funds rate unchanged at 0.25 percent, as expected, and stated that rates were like to remain “exceptionally low” for an “extended period.” At the same time, the FOMC said that they had reduced their planned purchases of agency debt to $175 billion from $200 billion, but repeated that they would be completed by the end ofQ1 2010. Though it wasn’t stated, it’s fair to assume that their Treasury purchases worth $300 billion have been completed, as indicated during the Fed’s September meeting.

Initially, the US dollar and the DJIA dropped sharply, but after about 30 minutes, prices diverged as the greenback tumbled and US equities reached fresh intraday highs. The only clear move was in Treasury yields, as the yield on 2-year notes fell slightly while 10-year yields rose by 8 basis points while 30-year yields gained 9 basis points, as of 14:50 ET, indicating that the markets are taking the Fed’s words on “exceptionally low rates” to heart in the near-term, but anticipate higher rates of inflation in the long-term.

US economic news during the morning was broadly positive, as the ADP employment change reflected a net loss of 203,000 jobs in October, which was slightly more than expected, but down from the net loss of 227,000 jobs in September (revised from -254,000). This was the smallest ADP decline since July 2008 and marked the seventh straight month of improvement from the record low of -736,000, suggesting that the deterioration of the US labor market is abating. Adding to evidence of this was the Challenger job cut index, which fell 50.7 percent from a year ago, the steepest decline since July 2006.

On the other hand, the Institute for Supply Management's (ISM) composite index on non-manufacturing conditions unexpectedly slipped to 50.6 in October from 50.9. With 50 being the point of neutrality for the index, the results suggest that the sector - which is the primary source of growth in the US economy - expanded for the second straight month, albeit at a very slow pace. A breakdown of the headline index shows that business activity improved slightly for the third straight month, prices paid and new export orders jumped, and new orders climbed for a second month. On the downside, the employment component fell to a five-month low of 41.1 from 44.3, running contrary to other leading indicators for Friday's US non-farm payrolls report.

Related Article: US Dollar to Remain Volatile Ahead of Four Major Rate Decisions and NFPs
 
Euro Gains on Speculation ECB Will Comment on Exit Strategies for Liquidity Programs on Thursday
The euro rocketed higher on Wednesday, and while it was due mostly to US dollar weakness, European data reflected notable improvements. The final reading of the Purchasing Managers' Index (PMI) for the Euro-zone services sector was revised higher than anticipated to 52.6 in October from the previous estimate of 52.3. This marks a nearly 2 year high for the index, a solid improvement from the September result of 50.9, and with 50 being the point of neutrality for the index, it also marks the second month of expansion in the sector. Likewise, the composite index - which also takes into account manufacturing sector activity - remained above 50 for the third straight month and was confirmed at a 22-month high of 53.0 in October, up from 51.1 in September. The data bodes well for Q3 GDP results for the region that are due to be released on November 13, as they may finally signal positive growth for the first time since Q1 2008.

Nevertheless, the European Central Bank (ECB) is anticipated to leave rates unchanged at 1.00 percent at 7:45 ET. Where the currency ends the day, though, may have more to do with what ECB President Jean-Claude Trichet says during his post-meeting press conference at 08:30 ET. Traders will likely focus on any comments regarding the future of interest rates in the region, including whether 1 percent should be considered the floor for rates, when rate increases may be on the way, as well as statements on exit strategies for the central bank’s liquidity programs, which is something that ECB Council member Axel Weber hinted at on October 29. At the time of writing, Credit Suisse overnight index swap (OIS) rates were pricing in 94 basis points worth of rate increases over the next 12 months, which is in line with the projections we've been seeing since mid-September, and if Trichet's comments keep OIS rates within or above this range, EURUSD is likely to continue making headway.

British Pound Up, but Uncertainty is Likely to Linger Ahead of BOE’s Rate Decision
The British pound rallied against the US dollar and Japanese yen, just like the rest of the majors, and from a fundamental perspective, UK news was rather strong. The Purchasing Managers' Index (PMI) for the UK services sector increased more than expected in October to a 2-year high of 56.9 from 55.3, reflecting the sixth straight month of expansion. However, the latest GDP readings for the UK have already shown that the economy contracted for the sixth straight quarter in Q3, this time by 0.4 percent. With GDP reflecting declines in nearly every sector, evidence suggests PMI may not necessarily be the best leading indicator of growth.

Uncertainly on the British pound may linger ahead of the Bank of England’s upcoming policy decision on Thursday at 7:00 ET. The BOE  is anticipated to announce that they’ve left rates unchanged at 0.50 percent, but this won’t even be the market-moving part of the announcement. Instead, traders will be looking toward the BOE’s policy statement. This has consistently been the prime “news event” of recent rate decisions. Last month, the BOE indicated a neutral stance as they stated they would continue their £175 billion quantitative easing (QE) program, and this ultimately led the British pound to rally against the US dollar and euro immediately. This time around, though, a Bloomberg News poll is calling for the Monetary Policy Committee (MPC) to expand their QE program by £50 billion to £225 billion following the Q3 reading of UK GDP, which showed that the economy remains in recession, and such a reading would have dire consequences for the currency. However, if the BOE allows the program to expire, the British pound is likely to gain.

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Written by: Terri Belkas, Currency Strategist for DailyFX.com
E-mail: tbelkas@dailyfx.com

DailyFX provides forex news on the economic reports and political events that influence the currency market.
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