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Tuesday May 3, 2005 - 21:11:29 GMT

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Forex: Dollar Sells Off On Fed Mistake

DailyFX Fundamentals 05-03-05

By Kathy Lien, Chief Strategist of

· Dollar Sells Off On Fed Mistake
· Carry Traders Send Pound Lower On Weak Data And Narrowing Yield Differential
· Speculation For Yuan Revaluation Continues To Escalate

US Dollar

To the surprise of anyone who stuck around to watch the newswire post FOMC, the Fed actually came out and said that they accidentally dropped the phrase “longer-term inflation remains well contained” from their statement. This slip by the Fed is quite unbelievable and makes us wonder if another fellow will be omitted from next month’s non-farm payrolls report. This re-addition of the phrase makes the statement even less hawkish and more disappointing than the original release because it suggests that the Fed may still believe that the pickup in inflation is temporary. In terms of the actual FOMC rate decision, as expected, the Federal Reserve raised rates by a quarter of a point for the eighth consecutive month to 3% and left in the phrases “measured” and “accommodative.” With no surprises from the Fed, the dollar did not deliver any blockbuster movements. Even though the market was divided on what changes the Fed would make to the statement, if any, going into the meeting, the majority did believe that the measured phrase would remain in place for at least another month. With mixed economic data released over the past few weeks, we have said that the Fed is in no rush to adopt a more aggressive stance, especially since they already upgraded their statement back in March. With the long-term inflation view back in the statement, there were only two overall changes – the Fed acknowledged that spending growth has slowed somewhat and they dropped the observation that energy prices have not fed through to core consumer prices. Basically the central bank is reiterating their belief that inflation pressures continue to grow, which paves the way for another quarter point rate hike in June. Eventually though, “measured” and “accommodative” will have to dropped from the statement and this could very well happen next month especially since annualized CPI is currently 3.1%. If the headline inflation index remains the same, when the Fed delivers their next bout of tightening, interest rates would be above the inflation rate, which means that monetary policy is no longer extremely accommodative. Pimco’s Gross expects the Fed to stop raising rates at 3.25%-3.5% - if the Fed really stops then, this confirms that the words measured and/or accommodative would have to disappear soon. For the time being though, traders have already shifted their focus to Friday’s non-farm payrolls report. Today’s Challenger report paints an optimistic picture for the labor market going into Friday’s release. According to the group, layoffs fell 33% in the month of April to the lowest level in 5 years. Factory orders also beat expectations rising 0.1% during the month of March.


The Euro finally mustered a rebound against the dollar thanks to the Fed’s disappointment. The latest batch of Eurozone data continues to paint the same bleak outlook that we have all become familiar with. Unemployment in the region ticked higher from 8.8% to 8.9% while producer prices increased at a faster pace during the month of March. Reports are expected from the service sector tomorrow and we expect to see a similar deterioration to the one that we saw in the manufacturing sector yesterday. With high unemployment rates in both France and Germany, retail sales should remain weak. This makes Thursday’s ECB rate decision an easy guess, as the central bank will once again be unable to do anything to help its faltering economy.

British Pound

The British pound sold off for the second consecutive day against the dollar following a disappointing manufacturing sector PMI report. According to the Chartered Institute for Purchasing and Supply, the UK manufacturing sector contracted for the first time in two years during the month of April. The CBI Distributive Trades survey also reported the weakest retail sales volume in 13 years. This combination of weak economic data has given pound traders and even better reason to exit long GBPUSD carry trades. The interest rate differential between the GBPUSD has now shrunk to 175bp from 200bp. Today’s Fed statement and economic data still suggests there are more rates hikes to come in the US whereas the UK’s data gives the Bank of England an even better reason to stand pat again next week.

Japanese Yen

After stealing the limelight for most of last week, USDJPY has fallen to the sideline today with the Japanese markets closed for a national holiday. Speculation of Yuan revaluation continues to be in full force although no new announcements have been made. Interestingly enough, following talks this evening in Istanbul between China, Japan and South Korea, China’s Finance Minister came on the wires saying that the Yuan was not discussed at the meeting. On the contrary, Japanese Finance Minister Tanigaki said it was indeed discussed but didn’t want to disclose the details, while South Korea said that no detailed discussions were held. We leave it to you to guess who may actually be telling the truth. In our opinion, with each passing day, we get closer to revaluation and it is now possible that an announcement from China could occur sooner rather than later. USDJPY has remained supported following Friday’s massive sell-off. China’s eventual announcement could be what it takes to see USDJPY head back towards its January lows.


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