By DailyFX - The Federal Reserve monetary policy meeting is now behind us and with no major changes to inflation...

... outlook and growth assessment, the impact on the currency market has been limited.


The dollar is slightly higher
across the board, but no new daily highs or lows have been achieved
after the rate announcement. The rally in the dollar represents the
markets relief that that the Fed did not address the problems in the
sub-prime sector. In fact, the Fed kept their comments on the housing
market virtually unchanged. As for inflation, even though they
acknowledged the fact that core price growth improved, they werent
entirely convinced that the battle has been won. Instead, they still
felt that inflationary pressures will refuse to fall. With oil prices
hitting an intraday high of $70.52, the Fed has good reason to be
worried. It should not be long before we see the national average of
gasoline prices move back above $3 a gallon. The Federal Reserve really
had no choice other than to keep the tone of the statement unchanged in
order to tame the stock market bubble. For a comparison between the
last two FOMC statements, see our Instant Insight. Although traders
will be watching tomorrows PCE deflator for evidence of growing
inflationary pressures, the more important releases will be personal
income and personal spending. Should the gap between spending and
income widen, then the US economy could seriously be in trouble,
especially since the market is looking for the gap to narrow
significantly. Beyond that, non-farm payrolls and service sector
activity next week will provide traders with better clues on how the US
economy is doing. For the time being, there is nothing to threaten the
immediate trend of the US dollar.

Carry Trades Rebound as Profit Taking Comes to an End, Party Not Over
Yet

Two days ago, we argued that the sell-off in carry trades represented
profit taking rather than liquidation. Today, the strength of the
rebound in the Yen crosses, particularly AUD/JPY, NZD/JPY and CAD/JPY
confirm that it will take more than a mere correction to put an end to
the carry trade. At the first sign of trouble, traders piled right back
into their Yen short positions. Japanese industrial production dropped
0.4 percent in the month of May, the third consecutive monthly decline
in manufacturing activity. Analysts were looking for very strong
growth; expectations were for industrial production to rise by 0.9
percent, bringing the annualized pace of growth up from 2.2 percent to
4.8 percent. Although retail sales and the corporate service price
index reported earlier this week were strong, the drop in industrial
production may prevent the Bank of Japan from raising interest rates in
July or August. Before rushing to judgment, it is important to wait for
tonights Japanese economic releases. We are expecting CPI, overall
household spending, the jobless rate, and manufacturing PMI. Whether
Japan sees inflation or deflation will determine where the Yen is headed
next.

New Zealand Dollar Hits 25 Year High as Strong Data Signals More Rate
Hikes

The Australian, New Zealand and Canadian dollars were the strongest
currencies of the day thanks the combination of higher commodity prices
and the resurgence in demand for carry trades. New Zealand economic
data also surprised to the upside with the first quarter current account
balance narrower than expected, consumer confidence accelerating and
building prices rising strongly. Money supply growth slowed slightly,
but that did not stop Finance Minister Cullen from warning that the
“economy is growing unsustainably fast” and “growing demand and
incomes have created inflationary pressures.” Even though Cullen is
not the head of the central bank (Bollard is), New Zealand government
officials are clearly aligned when it comes to monetary policy outlook.
Higher inflation and faster growth can only mean one thing, which is
more rate hikes. New Zealand and Canada both have GDP due for release
in the next 24 hours, so expect more active trading.

British Pound above 2.0 after Hawkish BoE Comments

The British pound broke above the 2.0 barrier following much stronger
than expected house prices in the month of June. Originally expected to
remain steady, house price growth doubled expectations. Next week, the
Bank of England is set decide on interest rates and given recent
economic data, there is a decent chance that the central bank will raise
interest rates to 5.75 percent. Bank of England Governor King said this
morning that the balance for inflation risks still remain on the upside
and indicated that 25bp hikes will not do much to hurt domestic
consumption. These are the words of a hawkish central banker which says
a lot a week before an interest rate decision. Tomorrow we have the GfK
consumer confidence report. No major changes are expected there as
stronger retail sales and higher house prices offset weaker average wage
growth.

Euro Sells Off Despite Stronger Labor Market and Inflation Picture

The Euro has sold off for the fourth consecutive trading day but the
degree of the four day weakness pales in comparison to the typical moves
that we are accustomed to seeing in the EUR/USD. Central banks like the
ECB must be delighted with this lack of market volatility and as traders
it has become the perfect currency to range trade. General interest in
trading the Euro has waned according to the latest FXCM Speculative
Sentiment index. Economic data released this morning was mixed. Even
though the unemployment rate dropped in Germany and the retail PMI
improved, a big drop in French retail PMI dragged overall Eurozone
activity lower. Money supply was higher than expected, highlighting the
inflationary pressures that the Eurozone still faces. German retail
sales and French unemployment are due for release tomorrow. Spending is
expected to drop after rising strongly in the month of April. However
the improvement in the labor market and the rise in the IFO consumer
survey suggest that another rise is not of the question.


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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