Wednesday February 2, 2005 - 21:59:20 GMT
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Dollar Reaction Muted As Fed Raises Rates Quarter Point, Leaves In “Measured”
DailyFX Forex Fundamentals 02-02-05
By Kathy Lien, Chief Strategist of www.dailyfx.com
· Dollar Reaction Muted As Fed Raises Rates Quarter Point, Leaves In “Measured”
· Euro Slides On 70 Year High In German Unemployment
· UK Construction Sector Growth Slows
We can now cross off this week’s first major event risk off our list today, with the rather mundane passing of the Federal Reserve’s monetary policy meeting. As expected, the Federal Reserve raised interest rates by a quarter of a point to 2.50%, increasing the US’ yield advantage over Europe to 50bp. However, despite the rate hike, the euro actually rallied marginally following the release, as there was a minor disappointment with the Fed’s decision to leave in the word “measured” in their statement. In fact, the Fed barely changed any of the text in their statement and indicated that they will continue to raise rates. With no notable reaction in the US dollar, the euro fell back on the exceptionally disappointing Eurozone data released this morning. Producer prices fell a more than expected –0.2%, confirming the ECB’s on hold stance. German retail sales fell for the fourth consecutive month, indicating that domestic spending may not be rebounding as significantly as the market may have expected. Unemployment also increased to the highest level in 70 years. Although most of the rise was attributed to the addition of welfare recipients to the jobless count, the rise above the 5 million threshold will certainly hit a psychological cord - labor market reforms will become more important at this point. However, Eurozone data today, like it has over the past few months, will only have a nominal affect on the EURUSD. Instead, the market will be looking ahead to tonight’s State of the Union speech by Bush and Friday’s non-farm payrolls report for its next catalyst.
The US dollar barely reacted on the Federal Reserve’s decision to keep interest rates unchanged. The event was expected to pass without much fan-fare after last week’s disappointing GDP report. What will be more important now is Friday’s non-farm payrolls report and Greenspan’s speech about the current account shortly afterwards (8:45am EST). Friday will be a big day, and as such more range trading could in the dollar’s fate tomorrow, although jobless claims, factory orders and the service sector ISM data is scheduled for release. Meanwhile, back on employment, Challenger, Gray and Christmas announced a 15% drop in layoffs in the month of January. This is the first time since August that planned layoffs dipped below 100,000. The way things are shaping up, even if we do not see a strong non-farm payrolls report for the month of December, we will certainly see one for the month of January. The last two jobless claims reports were very robust at 318k and 325k. If tomorrow’s report is equally impressive, it could drum up more optimism for the US dollar ahead of Friday’s report.
Trading slightly higher than yesterday, the sterling remained consolidated on relatively light economic data. According to the Chartered Institute of Purchasing and Supply, construction activity in Europe’s second largest economy rose slightly to a 55.5 reading compared with consensus expectations of a 56.8 showing. Although lower than the December reading of 57.2, the above 50 reading still indicates further signs of expansion in the industry in light of dips in housing activity and civil engineering. As a result, the domestic currency traded higher but met with strong resistance at the $1.8890 level and looks to continue in a 100 pip trap until further direction can be established next week when monetary authorities convene to decide on interest rates. With expectations of a stay on benchmark rates, market participants are not ruling out a rate cut consideration in light of recent signs of slowing industrial and manufacturing production along with a slowdown in housing prices. Once again confirming the sentiment of unchanged interest rates were U.K. interest rate future contract yields. Gaining 10 basis points since the onset of the new year, the yield has remained around 4.85 and signaled tepid expectations of increased rates.
Selling pressure emerged in an otherwise consolidated atmosphere as expectations of a disappointing leading economic indicators report mounted. Set for release on Friday, participants are expecting the world’s second largest economy to show signs of a slowdown in growth as the figure is estimated to be below 50 percent. This would be the fourth month the report has disappointed to the downside and would add to the recently pessimistic retail sales and staid industrial production data we saw last week. As a result of the drop in sentiment, investment capital began flowing into fixed income as 20-year bond yields dipped to the lowest level since March during the session. With many participants believing instability still looms, more formidable confirmation needs to be forthcoming in convincing yen bulls to reign supreme. Otherwise, notions of a flight to quality may be inevitable.
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