By DailyFX - The US dollar has strengthened ahead of the FOMC meeting despite the larger than expected drop in...

... durable goods orders in the month of May. The US economy is clearly facing problems as the weakness in durable goods follow disappointments in both existing and new home sales.

However, the problems in the economy will take a back seat to inflation
risks at tomorrows FOMC announcement. Consumer and producer prices
were both up in the month of May and based upon the recent increase in
corn and dairy prices as well as the mild change in the US stock market,
the Federal Reserve is not likely to loosen their leash on inflation.
Oil prices also jumped over 1 percent today after reports of lower US
fuel supplies. Crude prices are now $1 shy of its 9 month high. At
this point, the Federal Reserve does not have much choice other than to
keep the tone of the statement unchanged in order to tame the stock
market bubble. The key phrases to watch are the ones in reference to
the housing market and inflation. A bigger focus on housing market
problems will most likely lead to more pronounced dollar weakness
against the Euro than the Japanese Yen because the market anticipates
another interest rate hike from the European Central Bank this year
while shorting USD/JPY would require paying a hefty interest. By the
same token, if the tone of the statement remains unchanged, expect
USD/JPY to benefit more than the Euro. For a more detailed
outlook on what the Federal Reserve meeting could mean for the US
dollar, see our special FOMC Report.

Japanese Yen Skyrockets on Stronger Economic Data and Not Just Risk
Aversion

For the third consecutive trading day, the foreign exchange market has
been obsessed with the strength of the Japanese Yen. Rising risk
aversion continued to be blamed for the move, but with the Dow up over
90 points today, it is difficult to believe that investors are really
all that risk averse. Instead, the rally is more likely driven by the
turnaround in the Japanese economy. Having struggled to grow for the
past few months, we are finally beginning to see Japan reap the benefits
of Yen weakness. Last night, the country reported the first positive
reading in annualized retail sales in 8 months. This follows
yesterdays announcement that the Corporate Service Price Index
(CSPI) hit a 9 year high in the month of May. The combination of rising
consumer spending and growing inflationary pressures is just what the
Bank of Japan needs to see before raising interest rates again.
Industrial production which is due for release this evening is also
expected to swing into positive territory in the month of May. At this
point, there is also a decent chance that we will see stronger consumer
prices on Thursday. If everything prints positive, then a 25bp rate
hike on July 12 or August 23rd becomes a real possibility. With the Dow
rebounding and the FOMC announcement tomorrow afternoon, further carry
trade unwinding may be limited.

Euro Stuck in a Range; Swiss Franc Weakens After KoF

The Euro continues to be stuck in a tight trading range that is
typically more characteristic of a currency pair like EUR/GBP or
EUR/CHF. Economic data has been light with French business confidence
being the only piece of noteworthy economic data released from the
Eurozone today. Unlike German business confidence, which deteriorated
in the month of June, French business confidence was stronger than
expected. Overall, the Eurozone economy is still performing well enough
to warrant another interest rate hike from the European Central Bank.
ECB members continue to remain hawkish. Quaden reminded the markets
today that the central bank is closely monitoring upside inflation
risks. The FOMC meeting could drive some movement in the EUR/USD as
well as tomorrows German unemployment figures. Stronger employment
could pave the way for an upside surprise in German retail sales on
Friday. Meanwhile over in Switzerland, KoF leading indicators fell
short of expectations in the month of June. This led to broad based
weakness in the Swiss Franc.

British Pound Holds Steady as Markets Welcome in New UK Prime Minister

Next to the Japanese Yen, the British pound performed the best against
the US dollar today. After a 10 year rule under Tony Blair, UK citizens
and global investors are excited to welcome in a brand new Prime
Minister. Gordon Brown, the new man on the job has frequently been
credited for navigating the economy through its longest period of growth
in the past two centuries. His tenure as Chancellor of the Exchequer
has earned him respect from around the world. This sentiment has
allowed the market to shrug off weaker economic data. The CBI retail
sales index tumbled from 31 to 17 in the month of June, well below the
markets 25 forecast. Although cold weather has played a primary role
in slowing sales, the drop in spending suggests that we could see
deterioration in consumer confidence on Friday.

Commodity Currencies Slip After RBNZ Op-Ed Article

The Australian, New Zealand and Canadian dollars have all sold off
significantly despite the rebound in commodity prices. Economic data
was weaker than expected overnight, but much of the fall was related to
fear of further intervention from the Reserve Bank of New Zealand. The
RBNZ issued an opinion article on their website indicating intervention
is an ongoing process. Although intervention to date has been
futile, traders are not willing to take the risk. Meanwhile, New
Zealand also reported a weaker than expected trade surplus in the month
of May. This should not impact the first quarter current account
balance due out tonight because trade data in the first three months of
the year was healthy. Australia also reported softer leading indicators
for the month of April, which comes in stark contrast to the stronger
data that the market has become accustomed to seeing.



DailyFX Research Team
Forex Capital Markets LLC
32 Old Slip, 10th Floor
New York, NY 10004
Tel (212) 897-7660
Fax (212) 897-7669
E-mail: research@dailyfx.com


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