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Forex: Dollar Mixed Ahead of Bernanke’s First FOMC Meeting as Chairman

DailyFX Fundamentals 03-27-06

By Kathy Lien, Chief Strategist of www.dailyfx.com

• Dollar Mixed Ahead of Bernanke’s First FOMC Meeting as Chairman
• Euro Weakens in Fear of a Weak IFO
• Yen Rallies Ahead of Fiscal Year End

US Dollar

All is quiet in US trading ahead of tomorrow’s Federal Reserve rate decision. The dollar’s performance against the majors has been mixed, as it gained strength against the Euro, Canadian, Australian and New Zealand dollars, but weakened against the British pound, Swiss Franc, and Japanese Yen. Such divergent price action suggests that the market is jittery ahead of Ben Bernanke’s first meeting as Chairman of the Federal Reserve. In previous meetings over the past decade, it was frequently rumored that Alan Greenspan would pen the statement before the committee would actually meet. We doubt that the committee would allow Bernanke to get away with same, particularly since it is his very first meeting. As for the Fed funds target rate itself, the market has fully priced in another quarter point rate hike to 4.75 percent and in fact, has even already discounted a 80 percent likelihood of 5 percent rates in May. However what happens after that is up in the air since no one has a clear grasp on where the Fed stands after 5 percent. Yet if the Fed were to really stop at 5 percent, it is logical to assume that they would give some sort of signal to the market of their intention to first slow down their pace of rate hikes. If they were to do so, this would be one of the rare opportunities for the Fed to inject a more neutral tone into the FOMC statement. With the Fed raising interest rates continuously by 375bp, a clear sign that the end is near could cause a great deal of volatility in the currency market. Tomorrow’s release is therefore extremely important and could set the tone for the weeks to come. There is one more wrinkle, which is that regardless of whether the statement is changed significantly or not, there are five central bankers scheduled to speak this week. This means that the Fed has ample opportunity to explain or clarify their decision. Furthermore, the economic calendar is extremely busy, which means that if the statement was left unchanged, the dollar could still respond to the releases in the following days as traders feel the need to rely even more heavily on the data reports to predict the Fed’s next step.

Euro

Despite mildly firmer French production data, the Euro sold off in anticipation of another rate hike by the US Federal Reserve and prospects for a disappointing German IFO report. With the sharp fall in the March ZEW survey of analyst sentiment, the odds are that the impressive uptrend we have been seeing in the IFO survey may be over as well. A dip is certainly in the picture for the month of March and the more likely scenario is for the IFO to come in much further below expectations than the 102.9 consensus. If so, we could see the Euro dip below 1.20 in the early trading hours before the Fed announces its rate decision. The French business confidence survey came in right in line with expectations of 105, but the previous month’s number was revised higher from 105 to a 17 month high of 106. Meanwhile widespread strikes and demonstrations are set to begin tomorrow in France in reaction to the Prime Minster’s reforms to the Youth Employment Law. Although it is expected to cause some disruptions to traffic, we doubt that it would cause much disruption to the Euro. Traders are going to be more focused on the Fed rate decision, US consumer confidence and the German IFO report. Over in Switzerland, annualized retail sales remained unchanged at 3.1 percent. With the SNB President speaking this week and the KoF leading indicators due for release, both of which are expected to be positive news, we could see some bullishness in the Swiss Franc.

British Pound

Unlike the Euro, the British pound strengthened against the dollar thanks to firmer mortgage lending reports. According to the BBA, approved mortgages increased by 57.6k in February compared to 45k in January. This is yet another sign that the UK housing market is stabilizing, which is good news for consumer spending. Overall, we have been regularly seeing stronger data out of the UK. This week will be even more important in convincing the slowly diminishing amount of doves calling for another rate cut to join the neutral camp. The UK will be releasing more housing market reports as well as their fourth quarter GDP numbers. However, bullish data will still have to contend with the fact that as of Tuesday, the GBP/USD will turn into a negative carry currency. This is the first time that the UK will have lower interest rates than the US in approximately 5 years, which means that those who are long the GBP/USD will now have to start paying interest.

Japanese Yen

In typical pre-fiscal year end mode, the Japanese Yen is rallying as investors and companies repatriate their assets to “window dress” their books. Many insurance companies and pension funds also take this opportunity to rebalance their portfolios based upon changed market conditions. The Yen has also benefited from carry trade liquidation against the high yielding commodity currencies such as the Australian and New Zealand dollars. These external factors have allowed the market to shrug off weaker business outlook numbers. According to the Ministry of Finance, large companies felt less optimistic in the first quarter. After US Senators left China this weekend, Chinese President Hu is now set to visit the US in April. This will keep Yuan revaluation at the forefront of the market’s talking points.

 

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