Should USD Bulls be Worried About FOMC?

• Should USD Bulls be Worried About FOMC?
• NZD: What to Expect from RBNZ
• CAD: Backs Off 1.25
• AUD: Beware of CPI
• EUR Supported by SNB Intervention Talk
• GBP: Unfazed by UK GDP Miss

Should USD Bulls be Worried About FOMC?

The U.S. dollar traded lower against all of the major currencies ahead of the Federal Reserve's first 2015 monetary policy announcement. Given how crowded the long dollar trade has become, profit taking ahead of a rate decision is not unusual especially as some investors are worried that Quantitative Easing from the ECB will delay a Fed rate hike.  Judging from this morning's U.S. economic reports, there's not much for the central bank to be worried about. While durable goods dropped 3.4%, the index can be volatile and offset by the rise in house prices, new home sales and consumer confidence.  In fact new home sales rose by the largest amount in 4 months and consumer confidence reached its highest level since 2007.  However don't be mistaken, as shown in the table underneath this commentary, there has been more deterioration than improvement in the U.S. economy since the December monetary policy meeting.  Yet the table can be somewhat distorting because it comes after months of improvements. The Fed will also be reluctant to change their guidance after having only altered it mid-December.   

Last month, the Fed replaced its vow to keep rates near zero for a "considerable time" with a pledge to be "patient" on the timing of the first rate hike. The 450-pip rally in USD/JPY over the next 5 trading days showed that investors interpreted this as a hawkish shift.  If they dialed back their hawkishnesss now in response to 1 month of deterioration and changes in policy abroad, it would risk undermining their credibility. The Fed views the oil driven decline in CPI as transitory and doesn't believe that problems abroad will affect U.S. growth.  In other words we don't believe dollar bulls need to be worried about the upcoming FOMC announcement. There is no press conference or change in forecasts. The next major monetary policy meeting will be in March not January.  If the Fed provides no fresh insight at this week's meeting, their tightening bias should reinvigorate the rally in USD/JPY and drive EUR/USD back below 1.13.  However if they over-emphasize the need for patience, pointing to recent data, the dollar could fall sharply with USD/JPY dropping towards 116.

NZD: What to Expect from RBNZ

An hour after the Federal Reserve's monetary policy announcement, we will hear from the Reserve Bank of New Zealand.  Based on the recent price action of the New Zealand dollar, investors are bracing for dovish comments from the central bank. When the RBNZ left rates unchanged last month, Governor Wheeler described monetary policy as still expansionary, talked about the positive NZ economic story and indicated that the drop in oil prices helps disposable incomes. While he admitted that rates will remain on hold for a long term, his comment that the need for rate tightening has been pushed out was enough to satisfy investors who were looking for confirmation of the RBNZ's tightening bias.  In response, NZD/USD rallied more than 250 pips. This month, many people are worried that the surprise rate cut from the Bank of Canada and easing by the ECB will push the RBNZ to drop their tightening bias and adopt a neutral monetary policy stance. Based on the table shown below, there have been both improvements and deterioration since the December meeting.  Spending in general remains firm and while PMI manufacturing and services activity slowed between October and December, it picked up between November and December.  Most importantly dairy prices have stabilized, while the terms of trade and confidence improved.  We could be wrong and the RBNZ could shift to a neutral stance but given recent data and the decline in the New Zealand dollar, they also have every reason to maintain their hawkish bias.  Australian consumer prices are scheduled for release this evening and a decline could revive rate cut expectations, sending AUD/USD lower.

EUR Supported by SNB Intervention Talk

EUR/USD traded higher today on the back of U.S. dollar weakness and talk of intervention by the Swiss National Bank. EUR/CHF squeezed as high as 1.0381 after SNB Vice President Jean-Pierre Danthine said they are still prepared to intervene in the FX market.  As he explains, the ECB bond buys were seen as a big risk which implies that the SNB abandoned their peg to avoid losses.  The recent price action in EUR/CHF suggests that they have been in the market but with major forex brokers raising margin requirements on Swiss Franc positions, there has been thinner liquidity. EUR/USD raced to a high of 1.1425 intraday before giving up part of its gains. While the near term outlook for euro will be affected by the market's appetite for U.S. dollars, in the medium term, we are still looking for further weakness.  As we mentioned in Monday's note, the victory by the Syriza party in Greece creates ongoing uncertainty for the Eurozone. Elections in Italy are next. Furthermore, Quantitative Easing can mean even greater losses for a currency.  Remember, the first round of QE from the Fed led to a 900 pip decline in USD/JPY over the course of 3 weeks and the QE announcement from the BoJ last year drove USD/JPY from a low of 109 to a high just shy of 120 in 6 weeks time.  This means there is additional room for the EUR/USD to fall.  If 1.1200 is breached again, we could see the EUR/USD hit and most likely break 1.10. 

GBP: Unfazed by UK GDP Miss

The British pound traded higher against the U.S. dollar today despite weaker than anticipated GDP growth. The U.K. economy expanded 0.5% in the fourth quarter versus a forecast of 0.6%. Although this was beneath the market's expectations, the fact that GDP growth accelerated period between the third and fourth quarters on an annualized basis were perceived as positive for the U.K. economy in an environment where global growth is a premium.  Hawkish comments from BoE Governor Mark Carney and MPC member Kristin Forbes also helped to lift the currency.  While most economists are not looking for BoE to raise interest rates this year, the fact that some members of the committee remain hawkish confirms that the next move by the central bank may it be in 2015 or 2016 will be to raise interest rates. As long certain members of the BoE believe that tighter policy is still needed, sterling will outperform euro.