Markets Pared Gains, Awaiting FOMC

High-beta currencies pared back some of recent gains as investors are taking profits on risk markets ahead of FOMC rate decision today and, more importantly, ECB meeting tomorrow. Weak China manufacturing data is also weighing down on sentiments a bit.

USD/JPY is back pressing 78 level for the moment but lacks sustainable selling to push in through 77.94 support. Markets are generally very cautious and refuse to commit in either direction. Nonetheless, the yen could be given a boost further if Fed hints on additional stimulus today.

We expect the Fed would continue to leave the QE3 decision on hold in August as the better timing for action would be in September when two employment reports would be released for gauging the impacts of extension of operation twist in June. Moreover, a press conference will be held and staff forecasts will be published by then. Yet, what the Fed might do to drive sentiment in August might be extending the low rate guidance to 2015 and pledging the Fed would use whatever tools to stimulate the economy.

Markets are also getting cautious on the situation in Eurozone again as Spanish 10 year yield edged back to 6.75% while Italian 10 year yield is back above 6%. Expectations on ECB president Draghi after his comments last week raised hope on restarting bond purchases, as well as other crisis fighting measures. However, Germany has stepped up their opposition on some issues as ECB meeting approaches.

A finance ministry spokesman Blankenhiem said that "ESM treaty does not foresee a banking license, and we also see no need for a banking license for the ESM". And unnamed official from Bundesbank warned that ECB's focus should remain on monetary policy, implying opposition to bond buying. On the other hand, French President Hollande and Italian Prime Minister Monti issued a joint statement yesterday and welcomed Draghi's recent statements. They also urged to "use the measures and tools agreed upon as quickly as possible".

In Spain, it's reported that Economy Minister de Guindos will push for additional austerity, with cuts in health and education, as a condition to seek Germany's support for ECB's measures to bring down Spanish yield. Budget Minister Montoro is trying to impose stricter budget discipline in the country's 17 semi-autonomous regions with debt ceilings starting this year. Montoro said that all but four regions voted in favor of the debt ceilings. But finance head of Adalusia walked out from the meeting while that of Catalonia didn't turn up.

In China, the official PMI manufacturing unexpectedly dropped to 50.1 in July versus expectation of 50.4. HSBC manufacturing PMI came was finalized at 49.3. More PMI data will be released later today, including Eurozone PMI manufacturing final reading for July. UK PMI manufacturing is expected to drop slightly to 48.5 in July and could be market moving in case of downside surprise. US will release ISM manufacturing, as well as ADP employment report.