Pause Before Another Big FX Move?

Based on the price action over the past 48 hours in the forex market, volatility has declined as traders and investors wait for a fresh catalyst to drive the dollar higher. Better-than-expected U.S. economic data helped the greenback hold onto its gains against most of the major currencies but after such an extensive rally, the market is waiting for some confirmation that the Federal Reserve is on track to taper this year and won't do too much damage on the U.S. economy. The latest economic reports suggests that the economy may be able handle less stimulus but that is far from certain. As we said on Monday, the key is whether the other FOMC members are onboard with the idea. Right now, currency traders are in wait and see mode as they look forward to the next big catalyst -- which could come from the speeches by Fed officials.

A total of 10 U.S. policymakers are scheduled to speak this week on the economy and monetary policy but only three (Dudley, Powell and Stein) are voting members of the FOMC this year. We will be listening to these speeches closely to hear if these Fed Presidents are less supportive of tapering asset purchases this year than the Fed Chairman. Given how quickly and aggressively the dollar has rallied, a turnaround could occur if any of the three FOMC voters express skepticism or reservations about Bernanke's timing on reducing asset purchases. Remember, the decision to taper is subject to a vote by the current members of the FOMC. What we know is that Fed President Fisher, who is not a FOMC voter said a significant majority backed Bernanke's more optimistic tone last week.

Better-than-expected economic data helped the dollar hold onto its gains against most of the major currencies. Consumer confidence jumped to a 4.5- almost five-year high in the month of June. The Conference Board's index surged to 81.4 from 74.3. Despite the decline in stocks, U.S. consumers remain optimistic about the outlook for the economy, which will encourage the Federal Reserve to move forward with their plans to taper this year. New Home sales also rose 2.1% and while the pace growth slowed, it was much stronger than expected and sales in April were revised higher. Unfortunately homes remained on market for a slightly longer period of time and the average price declined. Nonetheless, there is still decent momentum in the sector. Durable goods orders rose 3.6% in the month of May thanks to a surge in Boeing aircraft orders. Excluding transportation, the gain was a more modest 0.7%. While the increase was less than the prior month, it was significantly more than expected. House prices on the other hand were mixed with S&P Case Shiller reporting faster house price growth and the House Price Index reporting slower growth. Final GDP numbers are due for release Wednesday but no major revisions are expected.

EUR: Holding Above Key Technical Level
While the euro traded lower against the U.S. dollar Tuesday, the sell-off stopped short of a key support level for the currency pair. Both Monday and Tuesday, the EUR/USD move stalled between 1.3060 and 1.3065. This level is significant because it is the 38.2% Fibonacci retracement of the July 2012 to February 2013 rally that took the currency pair from a low of 1.2042 to a high of 1.3710. It is also where the 50-, 100- and 200-day SMA converge with the first standard deviation Bollinger Band. With so many sources of support, there's no wonder that the EUR/USD is holding this level for the time being. No major euro zone economic reports released and the euro received very little help from ECB President Draghi who spoke this morning. The head of the European Central Bank said the "economic outlook still warrants an accommodative stance" which isn't completely surprising given the recent rise in European yields and the uncertainty that it creates for the region. Draghi did not mention the rise in yields but between his comment on the economic outlook and ECB member Coeure's comment earlier in the day that the exit from loose monetary policy is distant, the European central bank is trailing far behind the Federal Reserve, a dynamic that could keep pressure on the EUR/USD.

GBP: Supported By Stronger Housing Data
The British Pound ended the day unchanged against the U.S. dollar and slightly firmer against the euro. Before stepping down, Bank of England Mervyn King spoke to lawmakers Tuesday, saying that central banks are a long way off from tightening monetary policy. He feels the markets overreacted to Fed Chairman Ben Bernanke's comments when he announced that the US will reduce bond purchases later this year. King says interest rates need to be raised until adequate policies are in place. BOE Chief Economist Spencer Dale warned about threats to financial stability resulting from unnecessary risk taking. Dale worries that the central bank will lose credibility due to exceeding the inflation target for a long period. Dale said, "Trying to balance these three risks has been central to my policy decision over the past year and I expect it to remain so going forward." Deputy Governor Charles Bean said there are no technical obstacles in interest rates to negative levels but quantitative easing and Funding for Lending Scheme are more dependable ways than negative irates. The Data by British Bankers' Association revealed that approval for UK house purchases increased more than forecasted to 36,102 from 32,952 in May. Approvals for house purchases rose as the Bank of England and government implemented new schemes to assist buyers to enter the housing market.

AUD: Rebounds On Chinese Comments
The deeply oversold Australian dollar rebounded against the greenback while the New Zealand and Canadian dollars trickled lower. There were no major economic reports from Australia and New Zealand but tensions in Asia eased after a central bank official from China said that liquidity risk is controllable and they will keep money rates at a reasonable level. The People's Bank of China feels that the run up in SHIBOR rates is seasonal and will disappear gradually. The deep-pocketed central bank has plenty of flexibility to inject liquidity when they see fit. Also a number of bills are scheduled to mature next month, which should help boost the amount of money in circulation and ease lending rates in China. Meanwhile Canada's Mortgage and Housing Corp. lowered its forecast for housing starts this year amid modest economic and employment growth. Canada's housing market slowed in the last half of 2012 after the government tightened mortgage lending rules to head off a housing bubble but the market has recovered in the recent months. CMHC's Deputy Chief Economists Mathieu Laberge said, "So far in 2013, the average monthly growth rates for MLS (multiple listing service) sales, new listings and prices have all been increasing. The report said that the number of housing starts will drop 15% to 182,900 units and construction will increase 3.3% in 2014 to 188,900 units. CMHC said slow output and employment growth in the second half of 2012 indicated that housing demand has weakened. The report stated that risks such as record consumer debts and a rising supply of units in some markets echoed concerns expressed by the finance minister and BOC Governor Stephen Poloz.

JPY: Gradual Improvements In Economic Data It was a mixed day for the Japanese Yen, which traded lower against the greenback and higher against the euro. Corporate service prices increased 0.3% on an annual basis and 0.1% on a monthly basis. Among the components in the index, prices of advertising, transportation, communications and real estate were up. Japan's small business confidence also gained in June. Small business confidence rose to 49.6, the highest reading since March. However, the index still remains at a neutral level. Business confidence is forecasted to improve to 50.7 in the coming month. The BoJ has pledged to double its monetary base by the end of next year while Prime Minister Shinzo Abe promised public spending, tax reform and freer markets to reinvigorate Japan's economy. However BoJ Deputy Governor Kikuo Iwata said he would focus on long-term policy options to help build a sturdier economy through fundamentals. According to the World Bank it's been 21 years since Japan's annual inflation exceeded 2%.

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