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Fed Offers New View - "Increasing" QE - and Sends US Dollar Lower

Fed Offers New View - "Increasing" QE - and Sends US Dollar Lower

Christopher Vecchio, CFA, Senior Strategist

THE TAKEAWAY: USD Federal Open Market Committee Policy Meeting > Fed Funds Rate on hold at 0.25% > No direct language on recently slower growth > “Increase” QE introduced as phrase > EURUSD BULLISH / USDOLLAR NEUTRAL

The Federal Reserve policy meeting today went off without much ado today, providing the first let down in the three big events on the calendar this week (the European Central Bank Rate Decision is tomorrow and the US labor market report for April is Friday). As the dust settles, it’s evident that there were some key changes within the Fed’s post-meeting policy statement that have provoked some negativity by the US Dollar, although the USDJPY has produced a net-rally following the Fed Rate Decision, meaning the negativity can’t be too severe.

For the first time since QE3 was announced at the December 2012 policy meeting, Fed policymakers today decreed that they “are prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation as the outlook for the labor market or inflation changes." This is critical because recent inflation gauges (notably the Consumer Price Index and the Core PCE reading) and labor market reports (today’s ADP Employment Change (APR) and several of the past Initial Jobless Claims) have indicated that growth prospects may be slowing into the middle of the year.

The change in language regarding inflation is duly noted, as the Fed said price pressures were "running somewhat below" the mandated+2.0% y/y goal.When viewed in context of the jobs market that had "shown some improvement" in recent months, the importance of Friday’s US labor market report for April just increased significantly, as one of the two variables for more Fed easing may already be in policymakers’ range of increasing the pace of QE3. That, the Fed noted in its policy statement, wouldn’t change for now: "The Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month."

When the excitement dies down around the initial report, it is my belief that this may be viewed as a negative or dovish influence on the US Dollar, as there has been a marked dovish shift in the view on inflation as well as the direction in which monetary policy could travel next: ‘“increase” QE’ has now been added to the lexicon.

EURUSD 1-minute Chart: May 1, 2013

Charts Created using Marketscopeprepared by Christopher Vecchio

Following the release, the EURUSD initially dipped to 1.3167 from the prerelease level of 1.3195, but soon rallied to 1.3222. At the time this report was written, the EURUSD had fallen back to 1.3206. Elsewhere, the Dow Jones FXCM Dollar Index (Ticker: USDOLLAR) was mostly sideways to lower, as the AUDUSD and GBPUSD had rallied slightly, while the USDJPY rallied as well (the Japanese Yen depreciated).

It is worth noting that the USDJPY followed the 2s10s Treasury spread wider (Treasury yields rallied), suggesting that additional QE is not necessarily being priced into the market; however, the 2s10s spread had narrowed consistently throughout the US trading session ahead of the Fed’s policy announcement, suggesting that the change in language was already priced in. Should the 2s10s spread narrow once more, the USDJPY is likely to fall back, and US Dollar weakness should become more pronounced.

--- Written by Christopher Vecchio, Currency Analyst

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