US Dollar Down Sharply Ahead of FOMC Decision

The DXY index shows that the greenback broke from a wedge formation, as indicated by the drop below a rising trendline near 80.30 connecting the June lows. The release of US economic data didn’t have much of an impact on the currency, and the moves are more likely due to traders trimming their long USD positions as the Federal Reserve started their monetary policy meeting today. They may also signal speculation about an expansion of the Fed’s quantitative easing (QE) program, but we’ll touch on that below. Looking to today’s news, the National Association of Realtors said that US existing home sales rose by 2.4 percent during the month of May to a 7-month high of 4.77 million. A further breakdown of this report suggests that the increase in sales is indeed a sign of recovery, as inventories fell to 9.6 months from 10.1 months while median prices rose to $173,000 from $166,000. That said, median prices still remain down a whopping 16.8 percent from a year earlier and we need to see far more evidence before we can truly say that the US housing collapse is over.

Wednesday’s 8:30 ET release of US durable goods orders are projected to show a 0.9 percent decline in May following a 1.9 percent jump in April, and excluding transportation the index is forecasted to fall 0.5 percent. The markets should keep an eye on non-defense capital goods orders excluding aircraft, as this number serves as a leading indicator for business investment. This component has remained negative over the past two months, and a continuation of this dynamic would not be supportive of outlooks for a slow recovery in the US economy. At 10:00 ET, the Commerce Department may report that new home sales rose again in May at a rate of 2.3 percent to 360,000.

The bigger piece of event risk for the markets looms at 14:15 ET, though, as the Federal Open Market Committee (FOMC) will release their latest policy statement. The FOMC is widely expected to leave the fed funds target range at 0.0 percent - 0.25 percent, and this should remain the case throughout much of the year. In fact, the FOMC started saying in January that they continue “to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for some time,” and they went on to say something similar in March and April. Furthermore, the last statement highlighted that the Committee's policy focus is to support the functioning of financial markets via QE and other measures that are likely to keep the size of the Federal Reserve's balance sheet at a high level. As long as we see these sorts of statements continue to be published, the news shouldn’t be too market-moving. However, the statement could send the US dollar spiraling lower if the FOMC announces an expansion of their QE efforts, and ultimately, any news that is positive for the stock markets may be negative for the greenback, which has been trading, at times, as a safe-haven asset.

British Pound Strong vs. US Dollar, May Target Resistance at 1.6500/25

The British pound was one of the weakest major currencies on Tuesday, gaining only against the ultra-weak US dollar and Canadian dollar, but unlike yesterday, economic data was actually quite a bit better than expected. The British Bankers Association (BBA) said that mortgage approvals jumped to 31,162 in May from 29,018, marking the second straight month of improvement and a 13-month high. The news suggests that the Bank of England’s reduction of their Bank Rate to a record low of 0.50 percent has had a positive impact. At the same time, though, UK mortgage lenders like Nationwide, Barclays, and government-owned Northern Rock have all said recently that they were raising fixed-rate mortgage rates, indicating that credit conditions remain restrictive as banks are reluctant to lend. From a technical perspective, traders should watch falling trendline resistance for GBP/USD at 1.6500/25 and while today’s GBP/JPY daily candle suggests the pair could bounce, the bounds of a head and shoulders formation remains in play, with the neckline at 155.00 and shoulders near 159.30/50.

Euro Rockets Higher as ECB’s Weber Signals Interest Rates at Floor

The euro gained against most of the majors, surging over 1.5 percent against the US dollar and breaking above falling trendline resistance at 1.3960. The currency starting making headway during the European trading session, as Markit Economics released flash readings of their purchasing managers' index (PMI) for the Euro-zone's services and manufacturing sectors, yielding mixed results for the month of June. Services PMI fell slightly to 44.5 from 44.8 while manufacturing PMI rose to a 9-month high of 42.4 from 40.7, and these moves ultimately pushed the composite PMI reading up for the fourth straight month to 44.4 from 44.0. That said, composite PMI has held below 50 for 13 straight months, indicating that the Euro-zone economic contraction continues, albeit at a slower pace. At the start of the US trading session, European Central Bank council member Axel Weber said that the ECB has “used the room for rate reductions that was created by waning inflation risks and a dramatic worsening of the economic situation,” suggesting that interest rates have hit a floor. As a result, Credit Suisse overnight index swaps moved to price in a 63 percent chance of a 25 basis point hike in July, compared to 13.5 percent last Tuesday, which helps to explain some of the euro’s strength today. Ultimately, though, the ECB is highly unlikely to do something along these lines given downside growth and inflation risks for the region.

Japanese Yen Consolidates Monday’s Moves as DJIA, S&P 500 Close Little Changed

The Japanese yen slipped against many of the majors on Tuesday, due to broad consolidations of the moves we saw in carry trades and equities on Monday, which is something we noted potential for yesterday. There are still downside risks for these assets, though. While 10 of the nation’s biggest banks have returned $68 billion worth of TARP funds, there are still indications that not all is equal among US banks. Indeed, according to a press release published by the FDIC on May 27, their "Problem List" of troubled banks grew during the first quarter “from 252 to 305 institutions, and total assets of problem institutions increased from $159 billion to $220 billion.” As a result, it’s important to keep the situation in perspective, as there are still significant downside risks to the health of the financial sector and the economy at large.

Terri Belkas is a Currency Strategist at FXCM.