Decision Day for the Dollar

Talking Points

·          JPYIndustrial Production corrects more than expected

·          UK Mortgage approvals rise

·          German unemployment improves on World Cup demand

·          FOMC decision day

The FX markets remained motionless overnight, all but ignoring all of the economic data from Asia andEurope as dealing desks around the world prepared for the FOMC decision at 18:15 GMT today. On the economic front German unemployment improved markedly contracting by -49K against expectations of -30K as World Cup continues to stimulate spending in Euro-zones largest economy. The fact that German national team has progressed to the quarterfinals is highly beneficial to EZ consumer sentiment both psychologically and economically.

While life is likely to come to a standstill in Germany on Friday as the country huddles in front of the flat screen monitors to root for its national team, in the FX market the focus remains squarely on the Fed with the market keen to know if the Fed intends to move rates to 5.50% or even possibly 5.75% level as early as August.  Despite dollar bears predictions of imminent doom once rates crossed the 5% threshold,  the US economy has remained remarkably resilient in the face of higher rates and persistently higher oil prices. However,  greenback shorts may not have been wrong, just early.  The US housing bubble, like all bubbles before it refuses to pop quickly as buying momentum persists beyond all reason.  However, the weekly MBA data clearly shows that this key sector of the economy is experiencing serious problems. Yesterdays data revealed that both the Market Index and Purchase Index are at new lows for the last 3 years. Another 50 basis points rate increase in the Fed funds rate is likely to drive up the cost of adjustable rate mortgages even higher, making housing less and less affordable for the majority of the US population.

For now the Fed has been able to tighten monetary policy without any detrimental effects to the US economy, but as it continues to ratchet rates higher, it raises the probability of a sharp contraction in housing  which in turn would lead to a significant slowdown in the overall economy.  That is why the FX market looks at the latest Fed actions with ambivalence. Traders like the ever increasing yield on USD assets but worry that these increases could trigger a US recession. This conflicting sentiment explains the lack of dollar strength  versus the euro, given the units substantial interest rate advantage. Nevertheless,  should the Fed statement strike a hawkish note today, it  may well push the EUR/USD below the 1.2500 level and possibly even towards the 1.2400 figure as momentum traders test the resolve of euro bulls.  Any hint of hesitation, however, and the euro could see a rally on a classic sell the news dynamic.

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