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DailyFX Forex Report 06-30-04

DailyFX Forex Report 06-30-04

By Kathy Lien

· Federal Reserve Raises Interest Rates By 25bp to 1.25%
· UK Economy Grows At Fastest Pace in 3 Years
· Flash Estimate of Eurozone CPI Eases

What could have been the biggest event of the summer in the financial markets turned out to be completely uneventful. Greenspan and company delivered no surprises and left the market with a noncommittal statement. For more on the rate decision, see the USDCHF comments. Moving away from the US and over to Europe, the market should heed the warnings of government officials, as the number of unemployed individuals in France increased by 14k in May. The market had initially predicted that unemployment would fall by 5k, however if you recall yesterday, French Prime Minister Jean-Pierre Raffarin warned that France’s jobless figures would “remain bad.” Meanwhile, the flash estimate of Eurozone CPI for the month of June eased modestly from 2.5% to 2.4%. This suggests that inflation pressures may have peaked. After rising to a high above $42 on June 1, oil prices have since fallen close to 13%. Tomorrow, there is a very heavy Eurozone economic calendar – we are expecting a number of PMI surveys, German retail sales, and labor market data for the entire Eurozone.

As expected, the Federal Reserve increased their target for the fed funds rate by 25bp to 1.25% and kept the word “measured” in their statement. Contrary to market expectations, the Fed played down recent inflation risks by saying that “although incoming inflation data are somewhat elevated, a portion of the increase in recent months appears to have been due to transitory factors.” To further solidify their point, they reiterated that, “underlying inflation is still expected to be relatively low.” However, in order to prevent the market from taking their softened views on future inflation the wrong way, the Fed added a caveat to give themselves ample flexibility by saying that ”nonetheless, the Committee will respond to changes in economic prospects as needed.” Without doubt, the Fed is expected to deliver more rate hikes this year. The next monetary policy meeting is scheduled for August 10th. The market is currently pricing in an average implied rate of 1.48% in August, which means that 25bp next month is not guaranteed. The reaction in the currency markets has been muted and mixed across different pairs, but the rally in bond prices across maturities tell us that those looking for a stronger and more hawkish stance by the Fed, was disappointed.

Although the FOMC rate decision has stolen quite a bit of the limelight from the events that happened earlier in the day, it does not undermine the strength of the economic data released from the UK today. First quarter GDP was revised to 0.7% m/m, with an annualized growth of 3.4%, which is the fastest pace of growth in 3 years. The current account deficit was also unchanged from a revised –5.3B in the first quarter. The market had initially expected the deficit to increase from –5.2B to –7.3B. The improvement came primarily from a less than expected decline in exports. The robust report confirms what we have known all along, which is that the UK economy has exhibited impressive strength. Unless we see more evidence such as yesterday’s weaker consumer confidence report and a decline in lending on secured homes, there will be a continued need for the Bank of England to tighten monetary policy in order to prevent inflation from becoming too excessive. Tomorrow, we are expecting the UK PMI report. Although the index has increased over the past three months, the CBI industrial trends survey released last Thursday suggests that the improvement in orders and output may have slowed.

June’s Tankan report will most likely show that the Japanese economy still maintains its optimism. Manufacturers expect the index to reach a 13-year high as momentum continues to be broad based. Both foreign and domestic demand seems supportive of the economy. Exports last week rose by 7.3 percent to a record amount of $48.5 billion. Profits are expected to be reported to be higher this quarter, as industrial production in April increased 2.3% above the Q1 average despite rising oil prices this year. However, the outlook for the next Tankan in September may be more cautious as real exports have started to decline marginally with slowing growth in China. In the last Tankan report released in March, the sentiment of large manufacturers increased by 5 points to 7. Non-manufacturer sentiment was also positive, rising from zero to 5. This broad based optimism was sparked by strong demand for exports from both the US and China. A revival in consumer spending was also supportive of business sentiments as the jobless rate began to stabilize.


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