Dollar Higher after Release of Hawkish FOMC Minutes (page 1 of 2)

FXCM - DailyFX Fundamentals 04-11-07

By Kathy Lien, Chief Strategist of DailyFX.com


US Dollar - The minutes from the last Federal Reserve meeting was hawkish, yet the dollar is struggling to rally. This tells us that those who want to be long dollars for carry and yield are already long while the rest of the market is more interested in countries that will be raising rates instead of leaving them steady. Even though the minutes say that "further policy firming might prove necessary," at best, the Federal Reserve will leave interest rates unchanged at 5.25 percent for the next six months as uncertainties in growth and inflation make it nearly impossible to raise rates. Comments from Fed Presidents Lacker, Mishkin, Fisher and Plosser have all been hawkish, confirming that rates will not be reduced anytime soon. At this point, Fed fund futures are only pricing in the probability of one interest rate cut this year. Steady rates could continue to drive demand for US dollars against the Japanese Yen, but against the Euro, British pound and Australian dollars, the greenback could under perform. All three of these central banks are expected to raise interest rates at least once this year. If the UK raises rates, they will once again have a higher yielding currency than the US. Australia will see an even greater yield differential to their favor while the Eurozone will narrow its yield disadvantage against the US. This is a carry seeking world and for the time being, there are more attractive carry opportunities elsewhere. The only piece of US data released today was the monthly budget deficit, which increased from -$85.3 billion to -$96.3billion. Looking ahead, we are only expecting jobless claims and import prices tomorrow - the rise in oil prices last month is expected to drive import prices higher.

Euro - Euro bulls are holding back until they hear from the horse's mouth (ECB President Trichet) that rates will continue to be increased over the next few months. In order for the EUR/USD to make a run for its all time high of 1.3667, we need to hear some strong words from Trichet. Not only does he need to suggest to the market that rates will be increased in May, but he also needs to indicate that rates will be increased beyond that as well. The hesitancy of the market reflects the possibility that the central bank President could also take a more dovish stance. Why? Because the EUR/USD is trading less than 1 percent away from its all-time high. As an export dependent region, the Eurozone is particularly sensitive to the value of the Euro. In the past, we have said that the path to a stronger Euro is through a weaker one and now, the path to a weaker one is through a strong Euro. The Euro topped out in December 2004 / January 2005 after a series of disappointing economic data. Although the economy is at a much better place now than 2 years ago, it will not be completely vulnerable to the recent run-up in the currency. One of the central bank's biggest concerns is inflation. A strong Euro automatically tightens the economy and reduces inflationary pressures, alleviating some of the need for the central bank to be exceptionally hawkish. However should ECB President Trichet pacify the markets by reintroducing the words "strong vigilance" back into his vocabulary, not only will the EUR/USD rally, but expect another record high in EUR/JPY.

British Pound - The British pound was the story of the day as it was one of the few currency pairs that managed to rally against the US dollar.