7 Things We Expect From The Fed

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management.

• Dollar Rides High into FOMC, 3 Things to Watch Next Week
• EUR: Plan B for Greece?
• GBP: Busy Week Ahead
• CAD: Lower Oil Offsets Stronger House Prices
• Fresh 4-Year Lows for NZD/USD
• AUD: RBA Minutes Next Week

7 Things We Expect From The Fed This Week

Between 3 monetary policy announcements, the ongoing Greek debt negotiation, key data from U.K., New Zealand and Canada along with the RBA and BoE minutes, we have a very busy week ahead of us. Of course the main focus will be on Wednesday’s FOMC meeting as the tone and guidance from the Federal Reserve will determine how the dollar trades for the next few months. On Friday, we outlined our 3 main areas of concentration – guidance, economic projections and the votes. We also talked about how the U.S. economy is gaining momentum after a slowdown in the first quarter and according to the latest economic reports, producer prices and consumer sentiment as measured by the University of Michigan index is on the rise. This is on top of the increase in wages, improvement in job growth and pickup in retail sales. Today, we want to take a closer look at what we anticipate from the Fed and the potential impact on the dollar.

We're looking for

1. No Rate Hike in June
2. Lower 2015 GDP Forecast
3. No Changes to Unemployment Rate Forecast
4. Dot Plot Changes to Confirm 2 Hikes this Year
5. One Dissenting Vote
6. Optimistic FOMC Statement that Acknowledges Data Improvements
7. Upbeat Yellen who Says Every Meeting this Year is an Option for Liftoff

At the onset, the dollar could slip on the back of lower economic projections but once Janet Yellen speaks and prepares the market for liftoff, the dollar could see upward momentum. With 72% of economists surveyed by the Wall Street Journal anticipating a rate rise in September, we know that the market is looking for confirmation of what is quickly becoming a popular view. While we also believe that the Fed will lay the foundation for tightening, it would be remiss to not discuss the downside risks for the dollar. The IMF and World Bank believe the Fed should delay liftoff until 2016 and the rapid gains in the dollar over the past few weeks provide the Fed with flexibility. They could opt to remain cautious and if they choose to do so, the dovish message would be a big surprise that could send the greenback tumbling as much as 2% this week.

AUD Traders, Beware of RBA Minutes

The Australian, New Zealand and Canadian dollars traded higher against the greenback Monday but AUD/USD bulls should be wary of the currency’s rally because Monday night’s RBA minutes were expected to be dovish. Earlier this month, RBA Governor Glenn Stevens said the central bank is open to further easing if it will be beneficial to sustainable growth. He felt that the currency was too strong and needed to fall further. We expect the minutes to echo these cautiously dovish views and encourage A$ traders to erase some if not all of Monday’s gains. There is very little support for Monday’s broad-based rally outside of a minor increase in gold prices. The New Zealand dollar on the other hand benefitted from an increase in service-sector activity. This improvement is surprising considering that the RBNZ cut interest rates last week. The only explanation is U.S. dollar weakness, which was also the main driver of CAD strength. The Canadian dollar traded higher against the greenback despite lower oil prices and a steep decline in manufacturing sales but the rise in existing home sales contributed to the strength.

Euro Bounces on Good Data and Greek Fatigue

Euro traded higher against the dollar Monday on the back of stronger Eurozone data, weaker U.S. data and Greek fatigue. On Monday morning we learned that Eurozone trade activity improved in April with the surplus rising to 24.3B from 19.9B. Exports increased while imports declined, which is what we would expect from a weaker currency. The decline in the euro in March and early April helped to solidify the region’s recovery. However it was weaker U.S. data that drove EUR/USD higher. Manufacturing activity deteriorated in May and June according to the Empire State survey, which turned negative last month and industrial production, which declined for the second month in a row. Greece is no closer to a deal. As reported by our colleague Boris Schlossberg, “the negotiations between Greece and its creditors broke up over the weekend after only 45 minutes of talks.” PM Tsipras says creditors have softened their demands for pension cuts but we doubt this is likely. “The currency market is in the midst of full on Grexit fatigue as the on and off nature of talks and the lack of any progress either way has frustrated both longs and shorts with the market reacting less and less to each daily headline. There are even reports that many institutional traders have turned to options in order to avoid the whipsaw volatility of spot. Still the general view of the market remains relatively complacent with options markets putting little premium on EUR puts as currency traders still view Grexit as more of a sideshow rather than an existential threat to the euro. If Greece does exit the Eurozone, the risk may not be existential, but nevertheless serious as the temporary impact could be deflationary unwinding some of the progress achieved by QE. That is why EZ officials continue to work hard on establishing a deal and why the ECB remains committed to its liquidity operations for the time being.”

Sterling Hits 6.5 Year Highs vs. JPY and AUD

The British pound started the week strong, trading higher against most of the major currencies Monday and hitting its strongest level versus the Japanese Yen and Australian dollar in 6.5 years on an intraday basis. According to Rightmove, house prices rose sharply in June and investors are looking forward to Tuesday’s consumer price report showing an uptick in price pressures. This is a very busy and important week for sterling. In addition to CPI, we have employment, retail sales and the Bank of England scheduled for release. The pound is trading well ahead of these reports but whether its gains can be sustained will be determined as much by the FOMC rate decision as U.K. data. Its been 6 trading days without a pullback in GBP/USD but resistance is close at 1.56. We are also watching EUR/GBP – if it drops to 0.7150, it could be a good level for a long entry.