Dollar faces headwinds as FOMC meets

Talking Points

  • Japanese Yen: Mixed Across The Board
  • British Pound: Inflation Unexpectedly Expands At Faster Pace
  • Euro: Investor Confidence Improves
  • U.S. Dollar: Retail Sales, FOMC Rate Decision on Tap

The U.S. dollar continued to lose ground against its major counterparts on Tuesday, and the greenback is likely to face increased volatility during the North American session as the Federal Reserve is widely expected to hold a cautious outlook for the world’s largest economy. As the EUR/USD falls back from a high of 1.3497, the lack of momentum to push back above former support around 1.3500 may keep the exchange rate with a narrow range as market participants waiting for the Fed’s last policy meeting in 2010, and comments from the central bank are likely to set the tone for future price action as Chairman Ben Bernanke casts doubts for a sustainable recovery in the U.S. The FOMC is widely expected to hold the benchmark interest rate at its current range between 0% and 0.25% given the ongoing slack within the private sector, and the central bank may see scope to expand monetary policy further in 2011 as it aims to stem the downside risks for growth and inflation.

Nevertheless, a spokesman for the German government talked down speculation for an expansion in the European Financial Stability Facility and said that there is no need to increase the EUR 750B fund as the governments operating under the fixed-exchange rate system embark on managing their public finances, but endorsed a rise in the European Central Bank’s asset purchase program as policy makers struggle to restore investor confidence. At the same time, the European Commission held an improved outlook for the region and expects the economic recovery to strengthen in 2012 as private sector activity improves, but warned that growth will be moderate in the following year as policy makers take unprecedented steps to lower the budget deficit. Meanwhile, the economic docket showed investor confidence in the euro-area unexpectedly rose to a four-month high in December, with the ZEW survey advancing to 15.5 from 13.8 in the previous month, and the ongoing improvement within the real economy may lead the EUR/USD to retrace the sharp decline from the previous as the central bank continues to talk down the risks for the region.

The British Pound fell back from a high of 1.5910 as investors scaled back their appetite for risk, and the shift in market sentiment could lead the GBP/USD to retrace the advance carried over from the previous week as risk trends continue to dictate price action in the currency market. Nevertheless, the headline reading for U.K. inflation widened to an annualized pace of 3.3% in November to mark the highest reading since May, while the core CPI held steady at 2.7% for the third consecutive month. Given the stickiness in price growth, the Bank of England is widely expected to maintain its current policy in the beginning of 2011, but there could be a growing split within the MPC as the central bank anticipates inflation to hold above the 2% target throughout the following year. In turn, the BoE minutes due out next week will certainly have a big impact on the British Pound as investors weigh the outlook for future policy, and hawkish comments from the central bank could lead the GBP/USD to retrace the decline from the previous month as market participant speculate the MPC to start normalizing monetary policy in 2011.

The greenback continued to weaken against the major counterparts, with the USD/JPY slipping to a low of 82.83, and the slew of event risks scheduled for Tuesday is likely to spark increased volatility in the currency market as investors weigh the outlook for future growth. Retail spending in the world’s largest economy is forecasted to increase another 0.6% in November after expanding 1.2% in the previous month, while producer prices are projected to fall back to an annualized 3.3% during the same period after growing 4.3% in the month prior. In addition, business inventories are expected to climb 1.0% in October following the 0.9% rise in the previous month, while we anticipate the Fed to maintain its pledge to keep the interest rate close to zero as the economic outlook remains clouded with high uncertainty.

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