By Gaurav Kashyap, Head of DGCX desk at Alpari ME DMCC
With markets left disappointed by the lack of action from the Fed, the US Dollar made some strong gains, on the week, appreciating 1% against the Euro, 0.78% against the British Pound, and 2.66% against Gold. The Indian Rupee fell to an all time low against the Greenback at 57.33.
With so much of the data coming out of the US being weaker than expected, many expected the FOMC to announce some form of QE3; the purchase of mortgage backed securities, a la QE1 or outright bond purchases, a la QE2.
Instead, the FOMC decided to extend their Operation Twist program, which was set to expire at the end of June, through to the end of 2012. The program sees the Federal Reserve swap their shorter-term bonds (with maturities of three years or less) for longer-term bonds (with a maturity of six years and more) in an effort to flatten the yield curve and increase long-term borrowing. With the markets expecting more aggressive measures, investors were left disappointed and markets slumped across the board, led by equities, commodities and higher beta currencies. The US Dollar basked in the FOMC's latest decision, making strong gains against its major counterparts and dropping commodities - Gold fell to 1570 levels while WTI crude sank to two year lows below $80 a barrel.
Perhaps more alarming were the Fed's downbeat forecasts for growth, employment and prices for the US. In its quad-yearly projections, the Fed projected weaker growth for the US in 2012 (US GDP was expected to grow 1.9%-2.4%, down from April's projection of 2.4%-2.9%), higher unemployment (the unemployment rate is expected to increase to 8.0%-8.2% from April's projection of 7.8%-8.0%) and lower inflation (revised down to 1.7%-2.0% from April's 1.8%-2.0%).
With lower inflationary pressure and weakening growth, many would question the Fed's lack of action on the easing front. However it seems that the Fed is still unconvinced with the recently flow of weaker data. Seasonal hiring has shifted up in the US by a couple of months, as a result of the warmer winter and this lag is now starting to take its effect on US hiring. Fed Chairman Ben Bernanke is going to have to see an extended run of weaker NFP figures coupled with larger losses in US equities before having to force his easing hand. Until that point, the recent bull rally against the US Dollar is stalled, and only improving liquidity conditions in Europe, along with weaker data from the US will keep currencies afloat against the Greenback.
Crude has been particularly fragile in the past weeks and judging by the most recent pricing action this week, further dips are likely in energy prices. A stronger Dollar, coupled with deteriorating global growth conditions will continue to weigh on energy prices.
Eurozone recession looks increasingly inevitable
The most recent German ZEW survey for economic sentiment dropped to -16.9 (Exp 2.3, Prev 10.8) while the ZEW survey for the EU sank to -20.1 (Prev -2.4) hinting that recession for the Euro-zone is increasing inevitable.
Looking at China, the growth prospects don't look any better- the most recent HSBC Flash Manufacturing PMI index came in at 48.1 (Prev 48.4), the lowest level in 7 months, and the weaker data hints that despite recent measures from the PBoC, growth continues to be patchy from the world's second largest economy. With the WTI crude contract closing the week below $80 a barrel, a move towards $75 is on the cards, and this would present the most favorable entry point for long positions.
Similarly, Gold looks attractive at 1530 levels, a channel which has proven to be good support in the past weeks.