By DailyFX - US Dollar. Compared to its open price at the onset of US trading, the EUR/USD is basically unchanged. We actually saw only...

... a mild amount of volatility today despite two major events on the US calendar.


The day has been interesting, but the price action less so. Broadly speaking the US
dollar is weaker on the day, losing the most ground against the Japanese
Yen. If we needed to sum up the day's activity in one line, we would
say that the US is delaying the inevitable. The Federal Reserve is
still leaving the door open for more rate hikes, but injected more
cautious wording while the US Treasury refrained from naming China as a
currency manipulator but toughened up their criticism by calling for
more rapid progress. Specifically, the Federal Reserve raised interest
rates by a quarter of a point to 5 percent, marking their sixteenth
consecutive rate hike. To the shock of the market, the Fed did not tone
down the FOMC statement significantly. They repeated that "some further
policy firming may yet be needed," but if you read carefully, you will
notice that the word "yet" is new. The reason why the dollar gave
back all of its initial gains is because the market is divided on what
to think feel about this new word. As a sign of hesitancy some say that
it means the Fed will raise rates in June but pause in May while others
say that a June rate hike is unlikely. We think that the statement
still has an air of hawkishness and suggests that even though we are
close to end of the tightening cycle, today's rate hike will probably
not be the last. Inflation pressures are still hanging over the economy
and traders also tend to forget that a weak dollar also boosts inflation
pressures by making imports more expensive, so the Fed is walking on a
very fine tightrope. There are still two more CPI readings till the June
meeting which means that they opted to postpone the inevitable by giving
themselves a chance to first reviews upcoming economic data. For the
time being, as the Fed has said in their statement, the extent and
timing of further increases will indeed be data dependent. As for the
Treasury, it seems that politics outweighed economics. The positive
comments on the initiatives and promises made by Chinese President Hu
and Premier Wen suggest that the US is trying to play nice and gain
political favor with China at this critical time. In line with our
introduction of a third scenario in yesterday's Daily Fundamentals,
the US chose the "middle ground" and refrained from branding China
as a currency manipulator but toughened up their criticism. They felt
that China was making "far little progress" on exchange rates and
that the Treasury will "closely monitor" any developments. Should
China not deliver any further changes, they could very well still be
named in November, especially if geopolitical tensions subside by that
time. The muted reaction on today's reports indicate that the US
dollar has become very oversold and there may not be any buyers left in
the market. This suggests that if retail sales comes in strongly
tomorrow, we see a deep relief rally in the dollar.

Euro

The Euro hit new 12 month highs today largely due to the market's
overall bearish dollar sentiment but hawkish comments from the European
Central Bank certainly didn't hurt. Despite the persistent rise of
the Euro, the ECB is showing no signs of backing off from their
intention to raise interest rates next month. According to ECB Weber,
"more rate hikes are needed, at least 25 basis points." He says
this even though he believes that first quarter GDP growth may have been
slightly less than 0.5 percent. The GDP release is due out tomorrow.
Overall, the ECB's clear determination to continue raising rates comes
in contrast to the market's confusion with the Fed's new "yet"
word * which should work to the Euro's benefit. Meanwhile economic
data was mostly positive today with the trade surplus rising in the
month of March. An 18.1 percent increase in exports along with a 28.3
percent rise in imports helped to bring the surplus from EUR 13 billion
to EUR 14.3 billion. However the current account came in weaker than
expected and the seasonally adjusted trade surplus was also lower, which
neutralizes the report a bit. Over in France, numbers were decidedly
better with stronger growth in both industrial and manufacturing
production.

British Pound

Mixed signals from the Bank of England has given the British pound
little direction. The sterling rallied against the US dollar but sold
off against the Euro. As expected, the BoE did notch higher their
inflation forecasts, expecting inflation to remain above 2 percent
throughout the next two years. However, they also reduced their growth
forecasts for 2007 and 2008. Although the two changes are somewhat
conflicting, the Bank of England does believes that the slowdown in
growth will be "not much." The higher inflation pressures already
has the market talking about expectations for interest rate hikes over
the next year. According to the futures markets, a rate hike could come
as early as August with one more down the road. A reinitiating of their
tightening cycle should shift the dynamic between the pound and other
currencies, especially if economic data continues to improve. The UK
trade deficit came in better than expected for the month of March as it
narrowed from -GBP 7.04 billion to *GBP 5.45 billion.

Japanese Yen

It is another strong day for the Japanese Yen as it continues to
strengthen against the majors. Much of the move has been in
anticipation of the US Treasury's FX report which explains some of the
retracement afterwards. Although the market is still speculating that a
rate hike could come soon from the Bank of Japan, it is worth noting
that the government is fighting them once again. LDP Yamamoto cautioned
the BoJ against rushing to raise rates. The public battle between the
BoJ and the Japanese government is something that the market has grown
very much accustomed to. More often than not, this tension has delayed
any intended changes. Japan's leading indicator index dropped from 90
percent to 60 percent in March with the coincident index also falling
from 50 percent to 11.1 percent. This is the first time in six months
that the index is below the 50 percent contraction / expansion mark.


Kindest Regards,

Kathy Lien
Chief Strategist
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: klien@fxcm.com

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