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US Dollar Rips then Dips Following Fed Decision to Continue Twist

US Dollar Rips then Dips Following Fed Decision to Continue Twist

2012-06-20 20:27:00
Christopher Vecchio, CFA, Senior Strategist
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UPDATE: US Dollar Rally Resumes Following Bernanke Testimony

EURUSD 5-min Chart: June 20, 2012

US_Dollar_Rips_then_Dips_Following_Fed_Decision_to_Continue_Twist_body_EURUSD0.jpg, US Dollar Rips then Dips Following Fed Decision to Continue Twist

Charts Created using Marketscope – Prepared by Christopher Vecchio

Following Federal Reserve Chairman Ben Bernanke's testimony, the US Dollar has regained some of its losses (and lost gains), and is now the top performer on the day. The EURUSD, after rebounding to 1.2743, has since fallen back to 1.2657.

THE TAKEAWAY:Federal Open Market Committee Policy Meeting > Operation Twist Extended Through 2012 > No QE3 (yet) > AUDUSD, EURUSD Bearish; USDJPY Bullish

The Federal Reserve’s two-day policy meeting concluded today, and the first of the three major events surrounding the meeting has come across the wires. The Federal Reserve announced that it would keep its key interest rate on hold at 0.25 percent, as expected, but the big news was whether or not the Fed would choose to ease further. Indeed they have; but is it what the market wanted?

Instead of opting for a full-blow QE3 package, the Fed decided that it would instead extend Operation Twist. The extension, which will take place through the end of the year, will result in another $267 billion of purchases in the 6 to 30 year bond range, with those funds coming from sales of short tenor securities. As noted in our FOMC Preview, the Fed has just under $200 billion of short tenor securities left on its balance sheet.

EURUSD 1-min Chart: June 20, 2012

US_Dollar_Rips_then_Dips_Following_Fed_Decision_to_Continue_Twist_body_Picture_1.png, US Dollar Rips then Dips Following Fed Decision to Continue Twist

Charts Created using Marketscope – Prepared by Christopher Vecchio

In reaction to the announcement that no QE3 was coming along – just yet – the US Dollar strengthened across the board, as expected. The EURUSD dropped from 1.2690 ahead of the policy statement release to as low as 1.2636 in the minutes soon after; however, a flurry of comments from German Chancellor Angela Merkel suggesting that the EFSF/ESM could be used to help ease pressures in crisis-affected sovereign bond markets.

USDJPY 1-min Chart: June 20, 2012

US_Dollar_Rips_then_Dips_Following_Fed_Decision_to_Continue_Twist_body_Picture_2.png, US Dollar Rips then Dips Following Fed Decision to Continue Twist

Charts Created using Marketscope – Prepared by Christopher Vecchio

Unlike the EURUSD, the USDJPY rallied on the policy statement, and even after Chancellor Merkel’s comments, the pair remained elevated. The USDJPY is perhaps one of the best “tells” of the QE3 trade, in the sense that both currencies are considered safe havens and track Treasury yields closely; by no indication has the USDJPY thus far indicated that market participants are pricing in a higher likelihood of more easing in the coming weeks.

Presented below without commentary are key excerpts from the Fed’s policy statement:

On the economy:

  • The economy has been expanding moderately this year.
  • Growth in employment has slowed in recent months, and the unemployment rate remains elevated.
  • Business fixed investment has continued to advance.
  • Household spending appears to be rising at a somewhat slower pace than earlier in the year. Despite some signs of improvement, the housing sector remains depressed.
  • Inflation has declined, mainly reflecting lower prices of crude oil and gasoline, and longer-term inflation expectations have remained stable.

On expectations:

  • Economic growth to remain moderate over coming quarters and then to pick up very gradually.
  • Consequently, the Committee anticipates that the unemployment rate will decline only slowly toward levels that it judges to be consistent with its dual mandate.
  • Furthermore, strains in global financial markets continue to pose significant downside risks to the economic outlook.

On rates:

  • The Committee expects to maintain a highly accommodative stance for monetary policy.
  • In particular, the Committee decided today to keep the target range for the federal funds rate at 0 to 1/4 percent and currently anticipates that economic conditions--including low rates of resource utilization and a subdued outlook for inflation over the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.

On Operation Twist and further easing efforts:

  • The Committee intends to purchase Treasury securities with remaining maturities of 6 years to 30 years at the current pace and to sell or redeem an equal amount of Treasury securities with remaining maturities of approximately 3 years or less.
  • The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities.
  • The Committee is prepared to take further action as appropriate to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.

The Federal Reserve’s economic forecasts are due out at 14:00 EDT / 18:00 GMT while Chairman Ben Bernanke is set to speak at 13:15 EDT / 18:15 GMT.

To follow Chairman Bernanke’s press conference, visit DailyFX’s FX squawk box, the Real Time Forex News Feed.

--- Written by Christopher Vecchio, Currency Analyst

To contact Christopher Vecchio, e-mail cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

To be added to Christopher’s e-mail distribution list, send an e-mail with subject line "Distribution List" to cvecchio@dailyfx.com

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