The final gross domestic product (GDP) showed a slower than expected revision to 0.7% from the initial 0.6% figure, against consensus forecasts of a 0.8% rise. The figure remains the lowest in four years. Weekly jobless fell to 313,000 from a revised 326,000 in the prior week, with the four-week average is edged up by 1,000 to 316,000
Markets Brace for Fed's "Food" for Thought
While there is a strong possibility that today’s Federal Open Market Committee (FOMC) statement will acknowledge the recent slowdown in core inflation (good for stocks negative for the dollar), the main question is whether the Fed will introduce a note of concern regarding rising food prices having a sustainable impact on overall inflation. It is widely expected the Fed will maintain inflation as the “Committee’s predominant policy concern.” But with yesterday’s articles from the Financial Times and Washington Post reporting a possible new approach by the Fed in favor of more focus towards headline inflation, equities and bond prices may be upset by such a move, with the dollar likely to gain ground. Such new approach would imply a more prolonged hawkishness from the Fed, despite recent weakness in U.S. data in addition to the deterioration in housing.
The rationale of such a move would not only be explained by expectations of rising crop and fuel prices pushing up the cost of food, but also a tactical move to counter any excessive market optimism ahead of tomorrow’s core PCE price index, which could come in below 2.0%.
The possibility of introducing a new element to the FOMC statement in this month’s meeting is rather high, considering the fact that the last three FOMC meetings in June (June 2006, June 2005 and June 2004, June 2003) have consistently contained shifts in direction, such as a pause in rate hikes, a rate cut or the beginning of rate hikes.
In the event that the FOMC statement does balance its recognition of falling core inflation with an emphasis on rising headline inflation, the net effect may be negative for stocks, positive for bond yields and neutral to positive for the dollar as it implies ongoing hawkishness.
Sterling’s break of $2.00 may be short-lived
Sterling broke through the $2.00 level to as high as $2.0041 after the hawks of the Bank of England’s Monetary Policy Committee signaled the need for further rate hikes during their testimony to the Parliamentary Treasury Committee.
The higher than expected 1.1% increase in UK house prices in June was the highest since December while the 11.1% annual increase was the highest since December 2005, further bolstering the case for a July rate hike to 5.75%.
But sterling’s strength may be diminished later this afternoon in the event that the Fed statement sheds emphasis on rising headline inflation, in which case will boost the dollar by reducing expectations of a rate cut and especially weigh in sterling via renewed sell-off in equities, as these present prolonged erosion in risk appetite.
Interim support stands at $2.00, followed by $1.9970. In case the FOMC does not focus on headline inflation and does remove the word “elevated” from its description of core inflation, sterling could renew its run above $2.00, towards the $2.0040 target. Key resistance stands at $2.0075.
Euro’s rebound could erode on Fed’s food emphasis
The euro gained to as high as $1.3480 on a higher than expected May Euro zone money supply (10.7% y/y, from 10.6%) and bigger than expected drop in German May unemployment (-37,000 vs. -20,000 with unemployment rate at 9.1%, the lowest since March of 1995). But as in the case of sterling, the euro could erase its gains in the event that the FOMC statement introduces a new focus on rising headline inflation from higher food prices, in which case will boost the dollar by reducing expectations of a 2007 Fed cut. This is also expected to lead to protracted declines in U.S. equities, which will weigh on the euro via renewed sell-off in equities.
Interim support stands at 1.3440, followed by 1.3415. We do not see prolonged weakness mainly due to the recent data weakness and markets’ concerns with U.S. housing regardless of the Fed’s inflation focus. Upside capped at 1.3475, followed by 1.3525.
Yen off due to weak data, Fed statement could induce fresh selling
USD/JPY broke above the 123 figure due to unexpected decline in Japanese industrial production. But the ensuing resistance at 123.40 remains a key obstacle, which is only likely to be broken in the event of a combination of lower than expected jobless claims and a hawkish Fed. Yet we caution yen bears against a protracted decline in U.S. equities later this afternoon in the event that traders deem the Fed too hawkish in its statement. In such case, risk appetite will be curtailed, dragging USD/JPY towards the 122.70 support and 122.40.
CAD soars on rising oil
Our bullish case for CAD remains firmly in place after USD/CAD was dragged to 1.0614 following a new nine-month high in oil prices. Unexpected decline in U.S. gasoline stocks, and the decision by Exxon Mobil and Conoco to withdraw from Venezuela, boosted light sweet crude to $69.30. The breach below the support levels of 1.0640 and 1.0615 opens the door for 1.0585. Yet we do warn of the negative impact on CAD from renewed nervousness in U.S. equities ahead (and resulting from) Fed concerns with rising headline inflation. Upside capped at 1.0640. Key resistance drops to 1.0660.
Ashraf Laidi
Chief FX Analyst
CMC Markets US
140 Broadway, 30th Floor
New York, NY 10005
(212) 644-4220
a.laidi@cmcmarkets.com
