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Monday August 9, 2004 - 20:21:52 GMT -

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DailyFX: Fed Rate Decision – Will It Be About Face?

DailyFX Forex Fundamental Report 08-09-04

By Kathy Lien, Chief Strategist of

· Fed Rate Decision – Will It Be About Face?
· UK Producer Output Prices Increase To Nine Year High
· Japanese Yen Declines on Nuclear Power Leak


After Friday’s blockbuster day for the euro, today’s fluctuations in the single currency have narrowed to under 50 pips ahead of tomorrow’s FOMC rate decision. Given last week’s disastrous non-farm payrolls report, it seems that the Federal Reserve’s rate decision will be more about saving “face” rather than a decision based upon hard facts. Aside from the two consecutive months of weakness in job creation, second quarter GDP growth also came in way below expectations. According to a Bloomberg poll, the NFP report has prompted economists to reduce their third quarter GDP forecasts from 4.2% to 3.9%. As one of the first economic releases for the month, the payrolls report is an important lead-in for the data over the next 3 weeks. If companies are not adding jobs, then consumer spending, which accounts for 70% of the economy is also at risk. Taken together with the recent trend in oil prices, which hit another new record high of $44.98 today, consumers only have a stronger reason to curb spending. Meanwhile, although Eurozone data has had no substantial affect on currency rates over the past few weeks, it is still important to take note of this morning’s weaker Italian industrial production report and softer than expected second quarter GDP growth. Falling consumer demand has hurt the bottom line of both GDP and industrial production.

Fed Chairman Alan Greenspan’s credibility has really taken a beating lately. If you recall, only 3 weeks ago, he was surprisingly optimistic in his semi-annual testimony on the economy. He told us that the recent slowdown in growth, is merely “temporary,” and based upon the euro’s price action over the next few weeks, the market believed him. Only 4 of the 66 economists polled by Bloomberg expect the Fed to keep rates unchanged at 1.25% tomorrow. If the Fed does keep rates unchanged, they risk releasing a message to the market that implies that the economy is much worse off than they initially forecasted. Also, it would imply that they are at the mercy of short-term economic data (which is based upon past developments), rather than being proactive and moving based upon future expectations. Therefore in order to “save face,” the Fed will probably raise rates for the second time this year to 1.50%. What is more important than the tightening itself is the FOMC statement. The market expects the Fed to comment on the recent weakness in growth and employment. If the Fed fails to change their wording on the labor market (which currently says “the labor market conditions have improved”) and their assessment on the balance of risks (which right now in our opinion are slanted toward the downside), the dollar could get a modest boost as the Fed sticks to their game plan and the market once again cautiously puts their faith in the hands of their almighty Chairman.


Data from the United Kingdom continues to be mixed, which we believe could be a predecessor to slower growth. Today we saw positive data - output prices for producers increased by the fastest pace in nine years during the month of July, while input prices increased by a less than expected 0.6% on a monthly basis. This means that producers are increasing the prices that they charge their customers at a faster pace than the increases in prices that they themselves are being charged, which simply equals to fatter profit margins. According to the Office of the Deputy Prime Minister, house prices increased by a more than expected 13.9% in June. However, this is data for the month of June and not July. Previously, the FT and HBOS released conflicting figures for the month of June. The FT reported slowing price acceleration while HBOS reported faster house price growth. There will be more inflation data for us to make better judgments on the UK this week including tomorrow’s RPIX report and Wednesday’s BoE Inflation Report.


The dollar barely budged against the yen today, despite a number of important developments including a leak at a nuclear power plant in Japan that led to 4 deaths and news that UFJ Bank is currently considering the hostile take over from bid Sumitomo Mitsui. In terms of currency influences, we have countering affects. Japanese machinery orders increased a more than expected 3.9% during the month of June, which is the 22nd consecutive month of increases. Exports to China and North America remain strong. However oil prices once again surged to another all-time high slightly shy of $45 on news that Iraq stopped output following a threat of attack on their southern oil fields.

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