For Dollar Bulls, the Federal Reserve Fails to Deliver
The Federal Reserve cut interest rates by 25bp to 2 percent, which was right in line with the market’s expectations. However the US dollar sold off because the market was disappointed that the central bank did not give them more. This appears to be a classic buy the rumor sell the news type of reaction in the greenback since the statement was undoubtedly more hawkish than the one released in March. We noticed 3 major changes in the statement; First, two members voted to keep interest rates unchanged. Although Plosser and Fisher dissented last month as well by favoring a smaller rate cut than the 75bp of easing delivered on March 18th, they could soon convince some of their peers to follow suit. Secondly, the Fed took out their promise to act in a “timely manner” and instead, they simply said that they will act as needed. The statement about the downside risks to growth is also gone and even though we do not believe that the downside risks to growth have really disappeared, taking these words out of the statement is symbolic. Finally, the Fed reminded the markets that they have eased interest rates substantially (325bp since August) and over time, their efforts should have an impact on the US economy. For all intensive purposes, the Federal Reserve is telling the markets that the economy needs time to absorb their rate cuts and their toned down statement suggests that they will not be cutting interest rates again in June.

The futures market is currently pricing in a 78 percent chance that interest rates will remain unchanged at the next Fed meeting and a 73 percent chance that interest rates will also remain at 2 percent in August. Yet the US dollar sold off because the market is not confident in the Fed’s judgment. This morning’s Chicago PMI report and GDP reports were better than expected, but non-farm payrolls on Friday should be weak. So far, the central bank’s rate cuts have only had a limited impact on the US economy. It takes time before the monetary stimulus can be felt, but if it does not come through soon, an accelerated deterioration in the US economy could force the Federal Reserve to pick up where they left off. The FOMC statements have become longer and longer in recent months and the central bank’s increasing need to explain themselves can be worrisome for dollar bulls. A number of US economic data are due for release tomorrow. Manufacturing numbers should be dollar positive.

Eurozone Data Continues to Miss
The Euro strengthened against the US dollar today but that was due entirely to dollar weakness and not Euro strength. Economic data from the Eurozone continues to miss expectations indicating that a turn is underway. Business and economic confidence deteriorated in the month of April while German unemployment fell less than expected. Although ECB President Trichet said this morning that the Eurozone economy will be resilient in the first half of 2008, the cracks that have appeared are getting larger by the day. So far, the ECB has not shown any willingness to lower interest rates, but if economic data continues to weaken, they may have no choice but to do. We have previously said that a major turn in the Euro would occur if the ECB begins to cut interest rates at a time when the Federal Reserve is already done with monetary easing. We are moving closer and closer to that possibility as the two biggest questions hanging over the currency markets right now are when will the Fed stop cutting interest rates and when will the ECB begin. Meanwhile Switzerland reported weaker than expected leading indicators which are in line with recent reports.

British Pound Rallies Despite Weaker Economic Data
Like the Eurozone, UK economic data continued to weaken, but that has not stopped the British pound from staging a very strong rally. The strength in the sterling may be due to the news that HBOS PLC announced a GBP4 billion rights issue that is aimed at helping the bank bolster its balance sheet. However we are still worried about the outlook for the UK economy and for that reason we are also skeptical about the move in the British pound. Gfk Consumer Confidence figures declined to a 16 year low as fear of a recession and a depressed housing market continued to worry locals. Looking ahead, PMI manufacturing is expected to decline as similar weakness has been seen in the CBI survey.

Canadian, Australian and New Zealand Dollars Recover
The Canadian, Australian and New Zealand dollars have all recovered against the greenback. This sudden rally can be attributed to a readjustment of investor risk appetite, as economic remains mixed. New Zealand posted their Building Permits and Business Confidence figures, with both numbers falling short of expectations. These releases successfully foreshadow worsening situation in the housing market along with possibility of a rise in unemployment. Australia released their Private Sector Credit figures, which came in line with expectations, boosted by business and housing loans. Despite a rise in housing loans, expectations for Building Approval figures due out tomorrow remain to be pessimistic. Meanwhile Canada’s Industrial Product Price and Raw Material Price Index showed gains, due to rising commodity prices but GDP figures tanked to -0.2%, below market expectations.

Weaker Economic Data Drags Japanese Yen Lower
The Japanese Yen sold off against all of the major currencies except for the US dollar. Manufacturing PMI, household spending, housing starts and industrial production were all weaker than expected and this weakness should extend to tonight’s labor cash earnings figure. Japan is a big oil importer which means that the rising cost of fuel could take a bug toll on the Japanese economy.

Kathy Lien is the Chief Currency Strategist at FXCM.