Dollar: The Fed Decision will be a Litmus Test for QE3 Speculation

• Dollar: The Fed Decision will be a Litmus Test for QE3 Speculation
• British Pound Meets Event Risk for its Two Primary Concerns: Stimulus and Recession
• New Zealand Dollar Traders Will See Whether the RBNZ Will Yield to CPI
• Euro Traders Continue to Ease Off on Crisis Positioning, But Risk Can Change That
• Australian Dollar: Core Inflation Firms while Headline Slips, Which Matters?
• Japanese Yen Marks a Sharp Decline, MoF Confirms its First Deficit in Three Decades
• Gold Closes Out Only its Fifth Bearish Close this Year as Volume Shrinks

Dollar: The Fed Decision will be a Litmus Test for QE3 Speculation

There has been a notable downshift in the moderate - but persistent - risk appetite and Euro recovery trends that have defined the broader tendencies of the market over the past weeks. This is hardly the restraint of a steady market, rather it is the ominous retrenchment before a heavy round of serious event risk. There are a range of meaningful events / indicators that we should monitor for their isolated impact on their respective currencies, but there is also a heady risk from particular standouts that can potentially catalyze a latent drift in risk into a clear and driving trend in underlying sentiment. As the dollar happens to play the role of safe-haven-of-last resort, its position on any clear sentiment bearings should be relatively clear. Should we see a consensus of ‘risk on’, the EURUSD’s tentative bear trend reversal will easily clear its 1.3075 overhead, while the already buoyant risk-sensitive pairs (AUDUSD, NZDUSD and USDCAD) will charge new anti-dollar highs. Alternatively, a consensus of false optimism and a dim outlook will render the greenback an attractive buy at a recently discounted price.

In a day of many significant economic releases, the top concern is the Federal Open Market Committee’s (FOMC) rate decision. Normally, we would write this event off as a non-starter, but this is not our regular policy gathering. While the central bank will certainly leave the benchmark unchanged, we are going to get an unprecedented look at the policy authority’s policy outlook. New this meeting, the Fed will offer a forecast for interest rate expectations. This is certainly valuable, yet we have already had the call for rates to be held steady until the middle of 2013 burned into the back of our brains. What truly matters is the regular statement and Bernanke’s press conference. In this event, we have the opportunity to determine the possibility of and time frame for a further large-scale stimulus program (QE3).

Though we haven’t seen the central bank push forward the agenda of expanding its balance sheet further, speculation (perhaps hope) has led the market to price a significant possibility of such an outcome by approximately the second quarter of this year. Despite the warnings of an economic slowdown for global economy (the IMF added its voice to that call), the drop in earnings and the deterioration of the European financial situation, we have seen the S&P 500 and other risk-sensitive assets rise over the past weeks. This could very well be a reflection of stimulus expectations. If indeed QE3 is heavily priced into these markets and has artificially propped up asset prices, the absence of tangible confirmation could spell a serious fault in risk positioning and a tremendous spark for a dollar reversal. If it is confirmed, the dollar will suffer across the board.

British Pound Meets Event Risk for its Two Primary Concerns: Stimulus and Recession

While the UK data won’t pull at the underlying elemental fundamental strings of the global financial markets like the FOMC has the potential to, it can nevertheless significantly alter the strength and bearing of the sterling. We have two distinct events that speak to two different aspects of the pound’s health: growth and financial support. Set for simultaneous release, the Bank of England meeting minutes and advanced 4Q GDP figure each hold the potential for tremendous volatility. The growth figures are the easiest to interpret. The consensus is for a 0.1 percent contraction in the economy through the final months of 2011 which would confirm the fears of various policy officials and third party economy watchers that the UK is tipping into recession while the taint of financial crisis is spreading from the Euro Zone. The market has no doubt adjusted for a disappointing outcome, but given the seven day advance from the cable, it wouldn’t likely take much of a bearish surprise to encourage a correction. It is the minutes that carry the greater nuance. There is a growing belief that the central bank is prepared to follow up on expanding its bond purchasing program. Traders will be looking for confirmation in this statement. Risk of stimulus and recession and yet sterling is up…

New Zealand Dollar Traders Will See Whether the RBNZ Will Yield to CPI

The kiwi dollar is often held up to comparison to its Australian counterpart. And, it is in this comparison that the currency has found a bullish advantage. Where the RBA has started on a regime of rate cuts, the RBNZ has held firm in its neutral to hawkish lean. However, just this past week, we saw inflation New Zealand inflation pressures drop sharply. Has this set in motion a change in policy bearing? The RBNZ will tell us.

Euro Traders Continue to Ease Off on Crisis Positioning, But Risk Can Change That

The bigger fundamental concerns persist. Following up on the World Bank and EU’s own projections, the IMF has offered its own projection of recession for the Euro Zone economy (a 0.5 percent contraction in 2012). Furthermore, rating agencies are reiterating the reality that Greece is technically heading towards default. And yet, government bonds and the euro are rising. Is this a benefactor of stimulus hope?

Australian Dollar: Core Inflation Firms while Headline Slips, Which Matters?

There was some confusion with the release of the Australian CPI data and the market’s reaction. When significant data that has various components is released, the masses focus in on the headline figures first typically. That said, the headline 4Q CPI figure eased slightly. However, the core figure would firm. I would argue that neither will really change the RBA’s policy bearing and therefore sets a lasting tone.

Japanese Yen Marks a Sharp Decline, MoF Confirms its First Deficit in Three Decades

Perhaps the biggest move through Tuesday’s session was the tumble form the Japanese yen. It is tempting to saddle this with the easy label of manipulation and move on, but that would put us on the wrong path. We have seen the BoJ lower its growth forecast and the IMF while the Ministry of Finance confirmed its first annual deficit in 31 years. This is a serious issue for a trade economy. For the upcoming session, USDJPY watchers should look at the QE3 interest surrounding the Fed decision. If it doesn’t pan out, it could prove a long overdue bullish driver.

Gold Closes Out Only its Fifth Bearish Close this Year as Volume Shrinks

Though it curbs the consistent climb at an important technical boundary, gold’s bearish close was only the fifth since the year began. What is interesting is the conviction in the move. Tuesday’s futures volume was the weakest this year and points to another divergence. The precious metal will be heavily vested in the dollar’s reaction to QE3 speculation in the upcoming session.

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--- Written by: John Kicklighter, Senior Currency Strategist for DailyFX.com

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