Dollar weaker and hopes are high for QE3

Tuesday's FOMC statement will be closely watched to see what the world's largest central bank might have up its sleeve to make investors' pain magically disappear. But with central bankers around the world recently carrying out various forms of intervention even before global stocks fell for a second day, one wonders what tricks are left. Such are the forces in motion that any action can only be seen as being consigned to stemming powerful moves without addressing underlying problems.

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U.S. Dollar – The dollar declined against a basket of its major trading partners as equity index futures staged a strong pre-market rally. Investors are hopeful that the recent slide in stocks exacerbated by an S&P ratings downgrade will inspire the FOMC to announce further stimulative measures to restore growth and confidence in markets. Should they do so, this might be seen as negative for the dollar. The burning question ahead of the Fed’s statement is what it will do to stop the bleeding. The Fed is one of those places where cooler heads prevail and we might all be in for a surprise if the statement simply notes that the weekend downgrade provided one of those external shocks it has previously warned against and that it would now monitor the impact on consumer and business confidence going forward. It may also try to talk up the latest labor market release as an encouraging strand of evidence. In short, the FOMC will probably not announce further policy measures today despite the plunge in stocks for fear of pouring fuel on the fire. It may, however, warn that it stands ready with an open wallet in the event that recent market turmoil negatively impacts business activity.

Euro – The euro benefitted from hopes that the Fed might resort to further quantitative stimulus or at least state that it stood ready to maintain its open doors for an extended period. The euro rose to $1.4275 while rebounding also against the British pound to buy 87.36 pence. There was further evidence of a slowdown in the form of weaker than predicted German exports during June where a 1.2% dip contrasted against a rise of 4.4% during May. And although a 0.3% increase in the level of imports was higher than forecast, it was nevertheless moribund.

British pound – The pound is marginally higher against the dollar at $1.6339 and is relatively weak given its recent performance as a safe harbor within Europe. But maybe the better tone to the euro is today weighing around its neck and preventing an advance. There were also signs of weakness in today’s manufacturing data where industrial production stood still during June following a downwards revision to May data. Overall the year-on-year pace of change represented contraction of 0.3%. Manufacturing production also disappointed with output falling unexpectedly by 0.4% to leave the annual pace of change at 2.1%. In a further sign of a challenging external environment the trade deficit widened to £4.5 billion from £4.0 billion despite expectations it might narrow.

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