US Dollar Up Ahead of Fed Decision – What To Watch For

The US dollar gained across most of the majors today as US economic data surprised to the upside. Indeed, PCE Core accelerated to a six-month high of 2.3 percent, suggesting that price pressures are building throughout the US even excluding factors like food and energy costs. Meanwhile, personal income rose 0.1 percent while personal spending gained 0.6 percent, and though this was better than forecasts, both represent a post-rebate check disbursement slowdown in June. Looking ahead to tomorrow morning at 10:00 EDT, ISM non-manufacturing is anticipated to edge slightly higher to 48.7 from 48.2. The important thing to watch is to see if the index can rise above 50, signaling expansion in the sector. Will any of these factors change how the Federal Reserve decides to implement monetary policy? Unlikely. As Chief Strategist Antonio Sousa and I discussed in our FOMC Preview, the Fed will leave rates steady on Tuesday. The key to the direction of the US dollar tomorrow afternoon, though, has more to do with the FOMC’s bias in their policy statement. More than one dissent in favor of raising rates, or a clear focus on upside risks for inflation and inflation expectations could lead the US dollar to rally. On the other hand, a unanimous vote to leave rates at 2.00 percent, removal of the phrase noting higher inflation expectations, or any reference to re-emerging downside risks to growth should weigh heavily on the greenback. My fundamental bias for the US dollar on Tuesday: bullish. I anticipate the focus will be on inflation, but as we’ve seen in the past, this sentiment may not fully feed through until the day after. Thus, I would avoid trading the US dollar immediately after the news.

Euro Gains Versus British Pound, Yen as Producer Price Growth Hits Record High

The Euro-zone is experiencing no relief from rising prices, as the producer price index rocketed a record 8.0 percent in June from a year earlier. This was due primarily to 21.4 percent annualized jump in energy prices, and will do little to calm ECB President Jean-Claude Trichet’s hawkish bias. Though the ECB is anticipated to leave rates at 4.25 percent on Thursday morning at 7:30 EDT, we often find that Mr. Trichet’s commentary at 8:30 EDT is far more market-moving for the euro. Nevertheless, looking at more timely releases, Euro-zone retail sales are forecasted to have slumped 0.6 percent in the month of July. However, there is a risk that this figure will be even worse than predictions given the sharp drop in German retail sales during the same period. My fundamental bias for the euro on Tuesday: bearish. It’s worth noting that this release may only have a short-lived impact on the currency, especially when it comes to EUR/USD due to the US event risk on hand.

British Pound: Construction PMI Adds To UK Recession Risks

As if we needed additional evidence that the UK may be headed for recession, UK construction PMI hit yet another record low of 36.7 in July. Looking at a breakdown of the report, business activity and new orders appear to be grinding to a halt as the UK grapples with a housing sector collapse rivaling that of the US. On Tuesday, PMI for the services sector will hit the wires and is anticipated to hold below 50 and signal contraction for the third consecutive month. On the other hand, industrial production for the month of June is forecasted to rise a mild 0.1 percent, but given the weak results of the CBI Industrial Trends survey for the same period, there is potential for output to contract once again. My fundamental bias for the British pound on Tuesday: bearish. However, like the euro’s event risk, these UK releases may only have a brief impact on Cable.

Canadian Dollar: Weakest of the Commodity Currencies As Oil Tumbles

A nearly 3 percent drop in the price of crude oil futures to $121.41/bbl helped drive the Canadian dollar down on Monday, while the Australian dollar and New Zealand dollar struggled to make headway and ended the day little changed. Indeed, other commodities such as gold saw mild gains, helping to stem downward pressures on the Aussie. However, the currency faces heavy event risk overnight as the Reserve Bank of Australia will be meeting. The Board is expected to leave rates steady at 7.25 percent, but the market’s eyes will be on the RBA’s policy statement. The July statement was decidedly neutral, noting upside inflation risks and forecasts for more moderate domestic demand. Based on the economic indicators released since then, including a surge in Q2 CPI and drop in Q2 retail sales, this statement will likely be similar. My fundamental bias for the Australian dollar on Tuesday: bullish. The surprisingly strong inflation numbers could invoke more hawkish sentiment amongst the RBA’s Board members.

Japanese Yen Down Across the Majors As Risky Assets Consolidate

The Japanese yen slipped versus the majority of the majors, as indicators of risk sentiment – such as the CBOE’s VIX Index – and equity markets consolidate. There was no pertinent economic data on hand for the currency, though it’s questionable if that matters as the yen is likely waiting for the next big shift in risk appetite market-wide. Since Federal Reserve news can have a huge impact on US equity indexes, traders should look to Tuesday’s FOMC rate decision and policy statement, as this could be a major source of price action for the Japanese yen next week. My fundamental bias for the Japanese yen on Tuesday: mixed.

Mexican Peso Hits Nearly 6-Year High, Turkish Lira Holds Near 7-Year High

Emerging market currencies like the Mexican peso and Turkish Lira remain extremely strong as the Banco de Mexico and the Central Bank of the Republic of Turkey (CBRT) both remain hawkish and likely to hike rates again before year-end as price pressures remain strong. The latest inflation data was out of Turkey, as the annualized rate of consumer price growth surprisingly surged to a 4-year high of 12.1 percent. The news helped to keep Turkish lira bulls in the game after the currency gapped higher last week following news that the country’s Constitutional Court upheld the legality of the ruling AK Party in a narrow 7-6 vote. The country’s top prosecutor brought charges against the government of President Abdullah Gul and Prime Minister Recep Tayyip Ergodan, saying they violated Turkey’s strict secularism by introducing legislation such as removing a ban on the wearing of headscarves. Meanwhile, the South African Rand weakened as Naamsa Vehicle Sales held negative for the 16th consecutive month, pointing toward weakening domestic demand.

Kathy Lien is the Chief Currency Strategist at FXCM.