How Will FOMC Impact the Dollar?

• How Will FOMC Impact the Dollar?
• Euro Retraces Despite Progress in Greece
• AUD and NZD Vulnerable to Further Losses
• NZD: Shrugs Off Sharp 8.5% Slide in Chinese Stocks
• CAD: Oil Prices Drop to Fresh Lows
• Lackluster Rebound for Pound

 How Will FOMC Impact the Dollar?

Wednesday's Federal Reserve meeting is the most anticipated event risk this week and based on the uneven price action of the dollar, investors are waiting with bated breath for the FOMC statement.  The Federal Reserve is in no position to raise interest rates but with the market divided on September vs. December liftoff, the tone of the FOMC statement will have a significant impact on rate hike expectations.  When we last heard from Janet Yellen two weeks ago, she said she "expects growth to strengthen over rest of 2015" and indicated that the Fed doesn't want to wait much longer because "waiting longer might mean faster rate rises."  At the time, Chinese stocks had stopped falling and the Fed did not believe that the Greek debt crisis would have a significant impact on the U.S. economy.  Greece is not a concern today but Chinese stocks resumed their slide and the possibility of further losses and the recent pullback raises the fear that a deeper downturn in China's economy could affect the central bank's thinking.

Right now there's a greater than 50% chance that the Fed will raise rates in September but if China appears to be a concern for the central bank and the statement sounds indecisive, the dollar will fall quickly and aggressively as investors adjust their expectations for a move in December.  However at her semiannual testimony on the economy and monetary policy, Yellen made it clear that rates will rise in 2015 and we don't believe there's enough deterioration in the market or the economy over the past 2 weeks for her to backtrack on this view.  Although house prices and consumer confidence tumbled today, Markit Economics' survey of the manufacturing and service sector showed a pickup in activity.  At the last FOMC meeting, 15 out of 17 FOMC members believed that the first rate hike would happen this year and many other policymakers share Yellen's view that rates should rise sooner rather than later.  If the FOMC statement includes an optimistic assessment of the economy, the dollar will rise simply because the statement did not diminish the market's expectations for September tightening. Of course there's one other possibility - keep the statement virtually unchanged and leave the market guessing.  The June FOMC statement was the shortest in nearly 3 years. If the Fed hasn't made up its mind on September vs. December, the best option would be to leave the statement unchanged which could at the onset be perceived as a disappointment to dollar bulls.

Euro Retraces Despite Progress in Greece

After starting the week strong, the euro retraced against the U.S. dollar today, rejecting the 50-day SMA, trendline and Bollinger Band resistance.  No major Eurozone economic reports were released and today's U.S. economic reports were mixed, signaling that data was not to blame.  Chinese stocks also continued to fall although they ended the day well of their lows.  Therefore the reversal of funding currency flows should still support the currency.  Progress is also being made in the Greek debt talks according to EU officials and the ECB approved the reopening the stock market.  While stocks will probably trade sharply lower at the open, market dynamics are slowly returning back to normal. We did not believe that the EUR/USD deserved to rise as much as it had on Monday but after such a deep slide, a relief rally even if it is 1% is not unusual. For the time being, Greece no longer poses an existential threat to Europe and how the EUR/USD trades going forward will be determined by the timing of Fed tighteningPart of our bearish outlook for EUR/USD comes from our skepticism for Europe's ability to reach a deal smoothly with Greece but the other part stems from our bullish outlook for the dollar.  In the meantime, keep watching that 50-day SMA/first standard deviation/trend line resistance in EUR/USD.

GBP: Lifted by Stronger GDP

Sterling traded higher against all of the major currencies today on the back of stronger GDP growth. In the second quarter, the U.K. economy expanded by 0.7%, up from 0.4% in Q1.  While growth only met expectations and actually slowed on an annualized basis to 2.6% from 2.9%, investors responded positively to the report.  According to our colleague Boris Schlossberg, "mining and quarrying posted the biggest gains since 1989 but manufacturing declined the most since Q1 of 2013. On the other hand Industrial Production rose the most since 2010. There were no glaring problems in the UK GDP report as the country recorded steady growth in Q2 that should provide support for normalization of monetary policy sooner rather than later."  Rate hike expectations changed with the sell-off in Chinese stocks but if the Chinese government effectively stabilizes equities, sterling could extend its gains above 1.56. As this was the only major U.K. data this week, how sterling trades for the rest of the week will hinge on the market's appetite for dollars and euros.

NZD Pops Ahead of Wheeler Speech

The best performing currency today was the New Zealand dollar.  NZD rose more than 1% versus the dollar, euro and Japanese Yen. No economic reports were released from New Zealand dollar but investors bought kiwis ahead of RBNZ Governor Wheeler's speech.  After lowering interest rates earlier this month, the RBNZ toned down its comments on the currency by dropping the word unjustified from their description of the currency.  Today's price action suggests that investors believe Wheeler will be less dovish after having cut rates 2 meetings in a row.  We know that the RBNZ is still thinking about lowering rates again this year but three back to back rate hikes is unnecessary and that may be the view that Wheeler takes.  With this in mind we still believe NZD is a sell on rallies. Meanwhile a rebound in oil prices and rise in industrial product prices helped to lift the Canadian dollar. The Australian dollar also bounced, shrugging off the decline in Chinese stocks.