It has been a quiet morning in the foreign exchange market with the dollar trading lower against all of the major currencies. Today's U.S economic reports were mixed with house prices growing at a slightly faster pace but consumer confidence dropping to its lowest level since November 2011. The EUR/USD rose within a few pips of 1.35 on the back of the disappointment but backed off the key level quickly.

 

The U.S. Federal Reserve's 2-day meeting on monetary policy begins today with a decision expected on Wednesday.  No changes are expected and there will be no press conference or updates to economic forecasts at this month's meeting.  While the meeting will be less interesting as a result, it is still worth watching because there is a new cast of FOMC voters.

 

New Cast of FOMC Voters Not as Dovish as Expected

  

The new makeup of the FOMC will be extremely important because this group will decide whether asset purchases should end in 2013. Gone are Lacker (the most hawkish member of the FOMC), Pianalto (a dove), Williams and Lockhart. Three doves and one hawk will be replaced with two uber doves (Evans and Rosengren) and two moderate hawks (George and Bullard). Earlier this month, we had an opportunity to hear from George and Bullard.  As a moderate hawk, George expressed concerns about the central bank's ultra-easy monetary policy, warning that it could cause a surge in inflation, is disruptive to the market and may be difficult to exit from. She expects the economy to gain momentum and grow a bit more than 2% this year. Bullard was the wildcard and proved to be as hawkish as George. The St. Louis Fed President started off by saying that he expects U.S. growth to reach 3.2% in 2013 and 2014, which was more optimistic than George's forecasts. Bullard is "a little bit nervous about Fed policy" and believes there could be an inflation problem in the future because monetary policy is very aggressive. This implies that the new voting members of the FOMC may be a bit more eager to phase out asset purchases this year than previously anticipated.  Unfortunately we won't know if additional members supported this idea until the minutes are released on February 20th.

  

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U.S. Recovery on Track

 

What we do know however is that the U.S. economy is continuing to improve gradually as shown in the table below. While job growth slowed and the unemployment rate ticked slightly higher at the end of the year, retail sales rebounded, service and manufacturing sector activity expanded.  Sales of new and existing homes declined between November and December but the last data the Fed had on hand for the December meeting were the October numbers and more homes were still sold in December versus October. Stocks also performed extremely well climbing to 5-year highs while 10 year bond yields tested 2% for the first time since May.  The IMF believes that the U.S. recovery is on track and expects U.S. to lead growth in Westernized nations this year. However with job growth slowing and consumer confidence plunging, the Fed won't be overly eager to remove stimulus. 

 

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FOMC Language Changes to Watch For

 

If there are any changes to the FOMC statement, they will be minor.  The overall tone of economic data has not changed much since the December meeting.  As a result, we expect the central bank to continue to say, "economic activity and employment have continued to expand at a moderate pace."  They could remove the line that says "strains in the global financial markets" pose downside risks but the need for continued balance sheet expansion remains in place "if the outlook for the labor market does not improve substantially."  If the Fed leaves the FOMC statement virtually unchanged, the impact on the dollar will be limited.  However, if they change the statement enough to suggest that they have grown less dovish, we could see a new leg higher in USD/JPY.