Euro and Yen Enjoy Post FOMC Bounce

Talking Points

·          JPY inflation data shows gradual rise

·          UK GDP slightly better

·          German retail sales contract slightly

·          PCE deflator key in US session

Yesterday we noted that any hint of hesitation from the FOMC and the euro could see a rally on a classic sell the news dynamic. By stating that any additional firming "will depend on the evolution of the outlook for both inflation and economic growth" the Fed instantly depressed any expectations of another 25 basis point  rise in August and sent dollar bulls stampeding for the exits. As a result, the EUR/USD catapulted more than 200 points off its pre-FOMC lows as market sentiment made a major shift away from the greenback. With recent hawkish rhetoric from a slew of ECB officials now resonating through the market, traders will focus on the euro part of the pair expecting to see at least a 25 basis point and perhaps even a 50 basis point hike from the Euro-zone monetary authorities by August.  <?xml:namespace prefix = o ns = "urn:schemas-microsoft-com:office:office" />

However, much like the overenthusiastic dollar bulls, euro longs may be overestimating the true intent of Euro-zone monetary policy makers.  Given the tepid rate of consumer spending as  evidenced by the sharply lower than expected German Retail Sales the we believe the possibility of a 50 basis point hike in August is small at best. 

In contrast to the old dictum of speak softly and carry a big stick all of the G-3 central bankers appear to have adopted a policy of speak tough but act softly.  In the near term this tactic may be able to temper exchange rate movements, but should it continue for a long time,  monetary policy officials may lose credibility ultimately  leading to more volatility in the market. In fairness to all central bankers, it is far less politically and economically costly to jawbone the market rather than to actually influence it through tough monetary measures. Since all of the G-3 central bankers have to assess the political as well as the economic risks of their actions, this fact often blindsides market participants focused solely on economic issues.

Turning to <?xml:namespace prefix = st1 ns = "urn:schemas-microsoft-com:office:smarttags" />Japan we see that both economic growth and price levels continue to show steady improvement. Unemployment rate has reached yearly lows printing at 4.0% while job to applicant ratio has now jumped to 1.07 from 1.04 the month prior.  Most importantly Tokyo CPI increased 0.6% on year over year basis albeit the monthly comparison showed a small  decline. In short, the news continues to support the idea that ZIRP needs to be lifted no later than August.  Japanese monetary policy  has become hostage to the Fukui scandal, but should the TANKAN survey, due Monday confirm this latest positive string of economic indicators, the pressure on the Bank of Japan to abandon the Zero Rate standard may become so intense that the Fukui matter notwithstanding the BOJ officials may be forced to take action before summer ends.

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