By DailyFX - US Dollar. For the third day in a row, the US dollar has outperformed the other major currencies. The market is...

... continuing to readjust its expectations for the monetary policy meeting at the end of this month.


The Federal Reserve remains primarily hawkish with a chorus of Federal Reserve Presidents backing up Chairman Ben
Bernanke’s recent concerns for the buildup in inflation pressures. In the past 48
hours, we have heard from Bies, Livingston, Poole and Guynn. Of the four, only Bies
is a voting member of the FOMC. However, the solidarity within the Federal Reserve
comes at a critical time and tells us that barring any major unforeseen
circumstance, they will be raising interest rates by a quarter of a point in June.
Beyond that, it is up in the air. In the few months that Bernanke has been the Fed
Chairman, he has already proven to be rather wishy washy with the messages that he
has been sending out to the market. Liz Rappaport of Marketwatch published a
breakdown of recent comments by “Bouncing Ben.” According to her report, in
November at the Senate Banking Committee, Ben Bernake was hawkish and tried to
dispel any dovish perception. At the semi annual report to Congress in February and
in the March 28 FOMC statement, his tone was mixed to hawkish. However, in the
April 18 minutes for the March meeting and the April 27 Joint Economic Committee
testimony, he was surprisingly dovish, bringing up for the very first time the
possibility of a pause in the Fed cycle which caused a major wave of selling in the
US dollar. Then at the White House Correspondence dinner, Bernanke told CNBC
reporter Maria Bartiromo that the market misinterpreted his comments and from then
on, he started to be extremely hawkish. So in the course of one and a half months,
Bernanke has flipped from being mildly dovish to extremely hawkish. It is clear
that the Fed is placing far greater weight on inflation risks than economic risks,
but this may be a dangerous game that they are playing. We already saw extremely
weak payroll numbers and if the Federal Reserve continues to tighten monetary
policy, economic growth could suffer even more. This means that even though the Fed
has injected some dollar optimism into the market, further losses could remain
limited.

Euro
The market’s main focus tomorrow will be the European Central bank’s interest rate
decision. For weeks now, there has been rampant speculation on how large of an
interest rate hike the ECB will be delivering. The consensus is for a quarter point
hike but with economic data extremely positive and central bank members extremely
hawkish, there are some who expect a half point hike tomorrow. We think that this
is unlikely for a variety of reasons. First, even though the ECB is not currently
concerned with the value of the Euro, they could be if the currency trades above
1.30. Austrian Finance Minister Grasser says that as long as the Euro stays between
1.20 and 1.30, they are comfortable. A half point hike would catch most of the
market by surprise and easily shoot the EUR/USD above 1.30, into what is probably
the pain threshold for most Eurozone officials. Secondly, at their meeting
yesterday, finance ministers have already pleaded with the central bank to keep any
interest rate hikes at a minimum. The ECB will probably err on the side of
flexibility by being more conservative with rate hikes in the near term, raising
rates by only 25bp and saving the other 25bp as ammunition for the future. If
needed the ECB could easily opt to deliver an inter-meeting hike to ward off any
unexpected inflationary pressures. The central bank will probably remain hawkish
and they have good reason to be with a majority of economic data continuing to
surprise to the upside. This morning, retail sales and retail PMI all increased
strongly highlighting the continual recovery in the region’s economy.

British Pound
US dollar strength has pushed the British pound lower as the market looks ahead to
no changes from the Bank of England for the tenth consecutive month. Disappointments
in the UK come at a time when the outlook for its neighbor, the Eurozone is becoming
more promising. Tomorrow we are also expecting industrial and manufacturing
production for the month of April. Growth is expected to slow from the previous
month with annualized growth expected to remain flat. The only thing holding up the
British pound has been mergers and acquisitions. Switzerland based Novartis made a
GBP305 million bid for Britain’s NeuTec Pharma today while not too long ago, Spain’s
Grupo Ferrovial announced a GBP10.3 billion takeover of airports in the UK. The
free market principles of the UK is making the country’s companies more attractive
than US companies where potential bids have been met with push backs from the US
government. Unless the US relaxes its protectionism policies, this is a trend that
could very well continue, one that is negative for the US dollar.

Japanese Yen
The Japanese Yen is slightly weaker against the US dollar today as the stock market
takes a big tumble. Economic data continues to be positive with the leading
economic index at 50 percent, in line with expectations and the coincident index
increasing to 77.8 percent, slightly above expectations. Machine tool orders were
also strong, rising by 14.8 percent compared to 1.4 percent the previous month. A
report by the Chinese Economic Research and Advisory Program has recommended that
China continue to widen its trading ban and scrap tax breaks for foreign investors
to help reduce the country’s capital account surplus. More flexibility in China’s
currency is certainly the way to go, but as what has always been the mode of
operation in China, the government will continue to move on their terms. There is
minimal data due from Japan for the rest of the week which means that price action
will continue to be dictated by Euro and Yen movements.


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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