US Dollar Bulls Stay In The Game As Fed Rate Hike Speculation Goes Little Changed

The US dollar gained across the majors on Wednesday as the FOMC’s policy statement failed to quell speculation of 75bps worth of rate hikes over the next 12 months. Yesterday we said that the FOMC “essentially said that they would leave rates steady at 2.00 percent going forward, as they noted downside risks to growth and upside risks to inflation.” However, it appears that today, the markets took the line noting that upside inflation risks are of “significant concern” to the FOMC to heart. Regardless, we still do not believe that the Committee is willing to ignore slowing growth in order to fight inflation and inflation expectations. While the recent bounce in the US stock markets has left many optimistic, financial institutions are still not in the clear. The latest example: Morgan Stanley reportedly informed thousands of customers that they would not be able to withdraw money from their home equity lines of credit (HELOC). Is the credit crunch over? These customers would probably tell you “no.” That said, many of these clients’ properties had declined in value, making the move by Morgan Stanley prudent from a risk management perspective. Yet, it is still a clear sign that the days of free-wheeling lending is over, which will make paying bills increasingly difficult for consumers that are used to regularly drawing off of credit cards and home equity withdrawals. Looking ahead to Thursday, US pending home sales are anticipated to fall 1.0 percent in June, as demand for properties continues to wane. However, US dollar price action may have more to do with the outcome of the European Central Bank and Bank of England rate decisions, and as a result, my fundamental bias for the greenback on Thursday morning is bearish.

Euro: How Will The ECB Rate Decision Impact EUR/USD?

The euro continued its descent on Wednesday, getting a little help from the release of German factory orders, which plunged 2.9 percent during the month of June. With the European Central Bank announcing their rate decision on Thursday morning, weak Euro-zone data has had a bigger impact on the currency. While indicators have generally signaling that the region’s economy is slowing quite a bit, it will not be enough to lead the ECB to consider cutting rates as they are widely expected to leave rates steady at 4.25 percent after hiking by 25bps in July. The rate announcement will come at 7:45 EDT, but the big show is at 8:30 EDT when ECB President Jean-Claude Trichet will give his monthly press conference. Currently, overnight index swaps are pricing in a very small chance of a rate cut within the next 12 months, but the recent moves in EUR/USD have more to do with the fact that traders are also pricing in rate increases by the Federal Reserve during the same period. Yet, if Mr. Trichet’s commentary is hawkish enough to convince the markets that they have no intention of reducing rates anytime soon, the euro is likely to subsequently gain. However, it may take particularly strong words to ignite a significant rally for the currency, such as references to the ECB being in a state of “heightened alertness.” On the flip side, if Mr. Trichet focuses more on monetary policy being appropriately accommodative, suggests that inflation pressures could ease in coming months, or sounds significantly more bearish on the Euro-zone economy, EUR/USD could continue to fall. My bias for Thursday: EUR/USD could rally on Mr. Trichet’s comments, but the gains may be short-lived. According to FXCM SSI, forex traders are net long EUR/USD, and since the index is a contrarian indicator, the trend for the pair likely remains bearish. For more on the upcoming meeting, check out our Forecast for Euro, British Pound Ahead of ECB, BOE Rate Decisions.

British Pound: Can the BOE Rate Decision Prevent A Break Below 1.94?

The British pound plummeted nearly 100 points on Wednesday as traders continue to bet on nearly 50bps worth of rate cuts within the next year, according to overnight index swaps. However, none of those cuts are anticipated to come on Thursday when the Bank of England meets. In fact, the central bank is widely expected to leave rates steady at 5.00 percent this time around, but since the BOE does not typically issue a monetary policy statement when they do not change the Bank Rate, this could end up being a non-event. On the other hand, as we mentioned in our forex forecast for the BOE rate decision, since the British pound has fallen so sharply in recent weeks, the mere lack of a rate cut could be enough to provide the currency with a boost. My fundamental bias for the British pound on Thursday: bullish.

Canadian Dollar Gets Brief Boost From Ivey PMI, Watch Out For Aussie, NZ Employment Data

Declines in gold and oil prices continued to weigh on the Australian, Canadian, and the New Zealand dollar, with the USD/CAD pair rising for the third consecutive day to hold well above former resistance at 1.0450. The release of Canadian Ivey PMI provided a brief boost to the Canadian dollar, as the index fell less than expected to 65.5 in July from a previous reading of 69.6 in June. Looking deeper into the report, the employment component of the index fell to 46.3 from 58.2, hinting that labor market conditions are slowly deteriorating as firms grapple with higher raw material costs and slowing demand. Looking ahead, Australian labor data will be the main event risk for the Aussie over the next 24 hours, and may spur downside risks for the currency as the unemployment rate is anticipated to edge higher to 4.3 percent from 4.2 percent. Likewise, the New Zealand unemployment rate for Q2 is forecasted to rise to 3.8 percent from 3.6 percent, which could add to speculation that the RBNZ will cut rates again at their next policy meeting. My fundamental bias for the commodity dollars overnight: bearish.

Japanese Yen Down Across the Majors As USD/JPY Breaks Out

The Japanese yen fell versus the majors with the help of a surge in USD/JPY that marked the end of a long period of consolidation for the pair. Indeed, USD/JPY had been holding within a rising wedge formation for weeks, and finally managed to break above the February and June highs of 108.60. Meanwhile, US equity markets have managed to hold on to their recent gains, so does this mean that the carry trade is back? Risks for global markets remain high, but it appears that for now, risk aversion has faded. Indeed, traders can’t remain bearish forever. That said, I think this is a development worth watching and trading, but mostly because it is likely to eventually provide an opportunity within the next few months to sell carry/risky assets. Looking ahead, Japanese machine orders for the month of June are forecasted to fall 9.5 percent, which would be inline with recent comments by government officials saying that the growth is “deteriorating,” and that there is “a high possibility the economy has entered a recession.” My fundamental bias for the Japanese yen: bearish…for now.

Emerging Markets – South African Rand Down 0.7% as Strikes Shut Down Gold Mines

The South African Rand tumbled 0.7 percent versus the US dollar as a strike by the Congress of South African Trade Unions protesting high energy prices shut down gold mines in the export-dependent country. Meanwhile, the Mexican Peso and Turkish Lira edged lower amidst broad US dollar strength. There was no data on hand today, but tomorrow, South African manufacturing output is anticipated to improve, while Mexican consumer prices are forecasted to rise further. My fundamental bias for the Rand and Peso on Thursday: bullish.

Terri Belkas is a Currency Strategist at FXCM.