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Thursday April 24, 2008 - 23:34:02 GMT

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Forex Research - Will the Federal Reserve Leave Rates Unchanged Next Week?

Thursday, 24 April 2008 22:18:24 GMT

Written by Kathy Lien, Chief Strategist

• Euro Selloff Triggered By Drop in German Investor Confidence
• Bank of Canada Sees Cooling Growth, Bollard Hints at Future Rate Cut

Will the Federal Reserve Leave Rates Unchanged Next Week?
The headline reading of the Commerce Department's durable goods orders report contracted for the third consecutive month during March,  due largely to declines in demand for transportation and defense goods. However, the markets took their cue from the durable goods orders excluding transportation reading, as the index surged 1.5 percent and helped to keep the US dollar rally alive. Nevertheless, there were few other bright points in this particular report, as orders for non-defense capital goods excluding aircraft – a gauge of future business investment – went unchanged after two months of declines, suggesting that there is little potential activity in the business sector available to pick up the slack of diminishing consumer spending. Meanwhile, the US housing recession continued to reach news lows as sales of new homes plummeted 8.5 percent. Not only was this the sharpest drop on record, but it was also the fifth consecutive decline, marking the worst trend for the housing market since the second and third quarters of 2001. Overall, it is clear that economic activity in the US has slowed and evidence continues to point toward a recession. However, with inflation becoming uncomfortably high for the Federal Reserve, the markets are increasingly betting that the FOMC will not cut rates again on April 30 and this has underpinned the dollar strength we’ve seen over the past few days. Looking ahead, Friday’s University of Michigan consumer confidence index may not be much of a market-mover, as it is simply the final reading and the index will likely remain near 26-year lows.

Euro Selloff Triggered By Drop in German Investor Confidence
The euro continued to tack on additional losses on Thursday, but the sharpest move was triggered by the disappointing results of the German IFO survey. The measurement of German business confidence fell for the first time in four months, and led the euro to break below support at 1.58 within minutes. Indeed, rising energy and food costs, a strong regional currency, and tight credit conditions have dimmed the outlook for Europe’s biggest economy. Furthermore, ECB Governing Council member Michael Bonello killed the notion that every ECB member is hawkish, as he said during an interview with Reuters “I think current interest rates are sufficient for the medium-term strategy. I do not think that there is anyone who is considering higher interest rates." On Friday, economic data may support this sentiment as German import price growth is forecasted to slow to a 0.6 percent monthly pace, while Euro-zone M3 money supply growth is anticipated to ease back to a 10.6 percent annualized rate.

British Pound Remains Heavy, UK Q1 GDP May Determine Next Move
The British pound generally consolidated losses above 1.97 over the course of the day after UK retail sales fell for the first time in three months as the deteriorating housing market and restrictive credit conditions have started to weigh on sentiment. However, Cable faces heavy event risk from upcoming UK data, as Q1 GDP is forecasted to rise only 0.4 percent from Q4, while the annualized pace is anticipated to slow to 2.6 percent from 2.8 percent. Indeed, the minutes of the Bank of England’s April meeting showed that the Monetary Policy Committee noted that the “housing market was weakening, with prices falling, so there was an increased downside risk to residential investment and to consumption. But mortgage arrears and possessions still remained low, and employment had been rising…But it was still unclear how far these housing market developments would amplify the expected slowdown in consumption growth.” Nevertheless, as the MPC said, consumption and output has slowed, “but not yet by as much as expected at the time of the February Inflation Report.” Overall, the risks for this GDP report – and thus, the British pound – are to the downside, as tighter credit conditions and a marked weakening in the housing sector likely took a toll on domestic demand.

Bank of Canada Sees Cooling Growth, Bollard Hints at Future Rate Cut
It was a busy day for fundamentals and price action across the comm bloc today. Before fundamentals were even considered, the Aussie, Kiwi and Canadian dollars were all already under selling pressure thanks to a sharp declines across commodities spectrum. Key moves for these currencies were the near-2 percent drop in crude and 1.9 percent plunge in spot gold prices. And while the commodity-sensitive pair’s were already under duress, fundamentals would ultimately add to the downside moves for both the loonie and kiwi. Early in the Asian session, the RBNZ delivered an unsurprising rate decision. Governor Alan Bollard held rates unchanged at the record high 8.25 percent; but there was a notable change in the tone of the statement that followed the decision. The central banker suggested growth would cool more quickly than expected thanks to a drought combined with falling consumer and business confidence, faltering housing market and stiflingly high currency. The BoC was equally dovish in its monetary policy report with forecasts for domestic growth to cool to its slowest pace since 1992 and projecting the credit crunch to last through 2010. This is interesting rhetoric for a bank that has taken to 50bp cuts.

Japanese Yen Tumbles Ahead Of Inflation Numbers
Aside from the broad advance of the US dollar across the majors, the other FX theme was a rebound in risk appetite. This proved an unfavorable wind for the Japanese yen, which would fall over 100 points against the US dollar through Thursday’s session. However, the gravity of risk trends were relatively mild in comparison to past weeks, though fundamental over the coming week could quickly change that fact. Growth numbers from the UK and US and a FOMC rate decision could rouse caution; but for the yen, tonight’s CPI numbers will be front line event risk. The National numbers are expected to step up to a new decade high. Will this alter weak BoJ rate expectations? 




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