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ECB: One hit wonder?

- Currency Traders Tread Carefully on Fears that the Fed Will Be Non-Committal - British Pound Sells Off on Dovish Comments

DailyFX Fundamentals 06-23-08

By Kathy Lien, Chief Strategist of DailyFX.com

Currency traders tread carefully on fears that the Fed will be non-committal

The Federal Reserve begin their two day monetary policy meeting tomorrow and judging from the price action of the US dollar and reports from the press, dollar bulls are treading carefully on the fear that the Federal Reserve will be non-committal.

The continual rise in food and energy prices is adding to the burden on US consumers.

The unemployment rate jumped from 5% to 5.5% last month, the largest rise in over 10 years. Unfortunately the labour market is expected to worsen as companies like Citigroup and Goldman Sachs announce more layoffs.

With this in mind, many people are wondering whether Fed fund futures are overpricing rate hikes.

According to the pricing of the latest contracts, most traders expect two rate hikes before the end of the year. If this proves to be overly ambitious, the dollar could come crashing down as the prospect of interest rate hikes is the primary factor driving the dollar higher.

Over the past few weeks, the EUR/USD has been trading in a range as traders try to figure out who is more hawkish, the Federal Reserve or the European Central Bank.

After surprising the markets with hawkish comments on 30 April, currency traders not only expect the Federal Reserve to pause on Wednesday for the first time since August, but to also raise interest rates before the end of the year.

If a rate hike is coming, the Federal Reserve would need to toughen up their stance on inflation.

The tone of the FOMC statement and more specifically the degree of the Fed’s hawkishness will play a big role in determining where the US dollar is headed next.

Dollar bulls will not be happy with anything short of unambiguously hawkish comments from the Federal Reserve. Anything close to a wishy-washy statement will be dollar bearish.

With the Federal Reserve meeting right around the corner, the summer doldrums should not be with us for long. However in the meantime, we are expecting consumer confidence, the Richmond Fed Manufacturing index and the house price index.

Given the drop in the University of Michigan consumer confidence numbers and the Philly Fed index, tomorrow’s data could force the dollar to give back some of its gains.

ECB: One hit wonder?

It is becoming increasingly apparent that the European Central Bank may only be a one hit wonder this summer.

Although ECB President Trichet warned that interest rates could be increased next month, slowing growth may prevent them from raising rates further than 4.25%.

Unlike the Federal Reserve, Eurozone interest rates are high because the ECB has not cut interest rates throughout the Fed’s easing cycle. As a result, there isn’t a significant amount of room to raise rates.

On top of that, economic data from the Eurozone is taking a turn for the worse. Service and manufacturing PMI both dipped into contractionary territory, taking the composite PMI index for the Eurozone below 50, the lowest on record (the series started in 2005).

This explains why there has also been a sharp drop in German business confidence. With the prospect of an interest rate hike, the country is no longer immune to the damaging economic impact of higher oil prices.

Over the next 24 hours, we are looking forward to the German GfK consumer confidence numbers and French consumer spending – both pieces of data have greater downside than upside risks. Switzerland will also be releasing the UBS consumption index. Given the dovishness of the Swiss National Bank last week, consumption should be weak.

British Pound sells off on dovish comments

After last week’s stellar performance, the Sterling lost ground against the US dollar today, partially due to weak housing data, as the monthly Right Move house prices ended in the red.

Tighter lending conditions resulted in excess supply of homes in the UK, driving down prices. In addition, new research released by the Centre for Economic and Business Research indicated that slowdown in the economy could result in an excess of 300,000 employees being laid off in the near future.

Upcoming Nationwide House Price and GDP figures should provide more insight on the health of the economy. Any deviations from expectations should see the GBP sink further against the USD.

As more bad news comes rolling in, investors are becoming uncertain about a rate hike to fight inflation. BoE member Sentence said this morning that the central bank is in no rush to raise interest rates.

Oil refuses to retrace, boosting the Canadian Dollar

The Oil Summit in Jeddah this weekend has resulted in a whole lot of nothing. Saudi Arabia has simply confirmed that they will be increasing production by 200k barrels next month, but the Saudi rise was completely wiped out by further attacks on production facilities in Nigeria.

Unfortunately nothing significant came out of the Oil Summit which means that crude prices may not see any respite until the OPEC meeting in September.

This has helped drive the Canadian dollar higher on an otherwise quiet trading day.

The Australian and New Zealand dollars have given back some of their recent gains as new motor vehicle sales drop in Australia while visitor arrivals in New Zealand rebounded.

Dow clings to gains, quiet trading in Yen Crosses

The US dollar managed to gain strength against the Japanese Yen, as the pair tested the 108 level, in the intraday trading session.

Weak economic releases spelled losses for the yen, as supermarket sales figures showed a decline due to apathetic spending on household and clothing items.

In addition, BSI Large Manufacturing and BSI Large All Industry figures posted in the red, confirming suspicions that businesses continue to suffer from the recent rise in oil prices. The upcoming US FOMC meeting will determine where USD/JPY is headed.