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For Fed, There's More Confusion Than Clarity

For Fed, There's More Confusion Than Clarity

Kathy Lien, Technical Strategist

Just two days shy of this week’s FOMC meeting, some economic and market conditions suggest the time is right for tighter monetary policy, while others cast much doubt over the central bank’s next move.

The US dollar (USD) was able to recover earlier losses to end today’s North American session higher against most major currencies, showing us how much of a difference a few hours can make. With only two days to go before the Federal Open Market Committee (FOMC) monetary policy announcement, the big move in equities and the reversal in currencies suggests that traders are beginning to position for the much-anticipated meeting.

See also: The Key FX Event for This Week

Taking a look at how various markets are trading, however, there seems to be more confusion than clarity on what the central bank will say or do. The rise in the dollar and increase in US Treasury yields imply that currency and equity traders believe the main takeaway from this week's meeting will be that the central bank is gearing up to taper asset purchases.

However, the rally in US equities suggests that stock traders believe the Fed will make a point to distinguish tapering from tightening, and will reassure investors that cheap and easy money will remain available for a very long period of time.

If Fed Chairman Ben Bernanke is successful in convincing the market that the Fed will take a very gradualist approach to tapering, the US dollar could give up its gains. However, if Bernanke emphasizes the central bank's plans for tapering instead of tightening, the dollar could extend its rise.

It won't be an easy conversation for Bernanke to have, and with a press conference scheduled, he will have to answer some tough questions from reporters.

In the meantime, US consumer prices, housing starts, and building permits are scheduled for release on Tuesday, but speculation about the possible outcome of Wednesday’s Fed meeting will dominate market moves leading up to the announcement.

Big Eurozone Data Upcoming

The euro (EUR) ended Monday slightly higher against the US dollar, recovering earlier losses near the end of the NY session.

Tuesday’s German ZEW survey is expected to have a significant impact on the shared currency. Economists are looking for a small uptick in investor sentiment because recent economic reports have shown gradual improvements in the Eurozone economy. However, given the recent volatility in the financial markets, we would not be surprised if investor sentiment remained unchanged or deteriorated.

Meanwhile, between the G8 summit and Eurozone finance ministers’ meeting, we can expect a number of comments from European officials.

European Central Bank (ECB) President Mario Draghi will speak Tuesday, but he may not discuss monetary policy because the speech is at a farewell conference for the Bank of Israel Governor. The focus for Europe this week will be Thursday's PMI reports, but the ZEW survey can also cause some volatility for the euro.

UK Reports Record Housing Prices

The British pound (GBP) ended Monday virtually unchanged against the US dollar and euro. The only UK data released over the last 24 hours was house prices, and according to the report, prices rose 1.2%, making for a sixth consecutive month of increases.

UK inflation reports are scheduled for release on Tuesday. Consumer prices are expected to grow at a slower pace, but on annualized basis, CPI is expected to hit 2.6%, up from 2.4%. According to the British Retail Consortium, shop prices declined last month, which confirms that inflationary pressures declined.

Weaker CPI could stall the GBPUSD rally ahead of the Bank of England (BoE) minutes and Thursday's retail sales report.

Commodity Currencies’ Wild Ride

Monday was a rollercoaster ride for commodity currencies, which rallied in the early-US hours, then declined during the day, only to squeeze higher towards the end of the NY session. This volatility suggests that currency traders are not convinced that the outlook has improved enough for risk currencies to rally.

Mitsubishi's decision to suspend its $5.9 billion iron-ore project in Australia may have contributed to the AUDUSD decline, but it hardly explains the intraday reversal in the New Zealand dollar (NZD) and Canadian dollar (CAD) since both Canadian and New Zealand data was good.

The minutes from the most recent Reserve Bank of Australia (RBA) monetary policy meeting will be released Monday evening. When the central bank last met, the RBA refused to drop its bias to lower rates, choosing instead to say that while the exchange rate has depreciated, "it remains high considering the decline in export prices." A day later, we learned that GDP growth slowed to its weakest level since 2011, which may explain why the RBA left the door open to lower rates.

The RBA minutes are expected to remind the market about the central bank's level of dovishness, which could translate into additional losses for the Australian dollar.

“Abenomics” Under Fire at G8 Summit?

The Japanese yen (JPY) traded lower against nearly all major currencies on Monday as the recovery in Japanese and US stocks lifted risk appetite. The G8 summit is now underway, and while the civil war in Syria is atop the agenda, Japanese Prime Minister Shinzo Abe is expected to be asked a variety of questions about “Abenomics” as well.

Previously, some leaders felt that Japan was deliberately weakening its currency, but with the yen having appreciated more than 9% since the middle of May, Abe could easily point to the move and say that the accusations are untrue. As a result, we don't expect the G8 summit to have a dramatic impact on the yen.

According to the CFTC's Commitment of Traders (COT) report released last Friday, speculators are still very net-short yen. While the data was as of June 11, when USDJPY ended the day at 96, we doubt that positioning has changed that much since then.

The COT data also suggests that speculators remain confident that “Abenomics” will weaken the yen, and until some of those short positions turn into longs, the Bank of Japan (BoJ) will be hesitant about intervening in the currency.

The latest Japanese economic reports show continued improvements in Japan's economy. While the tertiary activity index fell short of expectations, the number isn't terrible when taking into consideration the sharp upward revision to last month's report.

Condominium sales in Tokyo also jumped 49.2% year-over-year. Industrial production and machine tool orders are scheduled for release Monday evening, but they are not expected to have a major impact on the Japanese yen.

By Kathy Lien of BK Asset Management

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.