FX: Top 10 Takeaways from July FOMC Announcement

• Dollar: Top 10 Takeaways from July FOMC Announcement
• Will EZ CPI Drive EUR/USD to Fresh Lows?
• GBP: The One Chart that Explains GBP/USD Weakness
• USD/CAD Climbs to Fresh 1 Month Highs
• NZD Shrugs off Rebound in Building Permits
• Busy Night for AUD
• USD/JPY Extends Gains, Japanese Data Weakens

Dollar - Top 10 Takeaways from July FOMC Announcement

This afternoon, the Federal Reserve reduced its monthly bond purchases by another $10 billion but instead of extending its gains, the dollar retreated because the statement was hawkish but not enough. Although the central bank was more upbeat on inflation, the labor market and consumer spending AND Fed President Plosser dissented because he felt the guidance did not appropriately acknowledge economic progress, investors were hoping for more specifics on when rates would rise or at least less of an attempt to downplay recent improvements. Instead the Fed replaced their reference about the unemployment rate remaining high with a line that says, "a range of labor market indicators suggests that there remains significant underutilization of labor resources." In other words, the central bank is still not satisfied with the improvements in the labor market and as a result, did not feel the need to alter its forward guidance.  The Fed plans to continue tapering asset purchases at a measured pace but rates will remain low for an extended period of time after Quantitative Easing ends.  The conservative central bank clearly wants to see another month of data before they change their guidance and the next realistic opportunity for an announcement of new policy direction will be in August after the Jackson Hole Summit.  In the meantime, here are our Top 10 Takeaways from the July FOMC announcement:

1. Bottom Line - FOMC Statement NOT Hawkish Enough
2. Dollar Gives Up Gains, Stocks Sees Some Relief, Yields Back Off Highs
3. Fed Tapers Asset Purchases by another $10 Billion
4. Decision was NOT Unanimous 
1. Hawkish Dissent from Plosser who believes Guidance does NOT Reflect Economic Progress
5. Drop in Unemployment Rate Not Enough
1. Fed Acknowledges Jobless Rate Improvement, Removes Reference that Rate is Elevated but sees Significant Underutilization of Labor Resources
6. Recovery Still Uneven
1. Housing Remains Slows but Moderate Pickup in Consumer Spending
7. Fed says Odds of Inflation Remaining Persistently Below 2% has "Somewhat Diminished"
1. Low Inflation is Becoming Slightly Less of a Concern
8. Intends to Continue Tapering at Measured Pace if Outlook Holds
9. Guidance Unchanged
1. Monetary Policy Remains Highly Accommodative & Rates to Remain Low After QE
10. Next Opportunity for Change in Guidance is the Jackson Hole Summit in late August

Meanwhile the U.S. economy rebounded strongly in the second quarter according to this morning's U.S. GDP report.  The economy grew 4% between April and June, easily beating the market's 3% forecast.  Personal consumption, business investment and inventory picked up significantly while price pressures increased.  On top of all this, Q1 growth was revised up to -2.1% from -2.9%.  The focus will now shift to Friday's non-farm payrolls report.  Although ADP reported a smaller increase in private payrolls during the month of July (218k vs. 281k in June), the outcome is still consistent with a steady recovery in the labor market.  Jobless claims and the Challenger Layoff Report are scheduled for release tomorrow and while layoffs and claims could rise no major upside surprises are expected. 

Will EZ CPI Drive EUR/USD to Fresh Lows?

Investors continued to sell euros today despite healthier economic data.  Inflation in Germany ticked up in the month of July and economic confidence in the Eurozone improved but geopolitical concerns and muted price pressures prevented the currency from rallying.  German CPI increased 0.2% in the month of July, which was stronger than the market's 0.2% forecast but on an annualized basis, CPI growth slowed to 0.8% from 1%.  Tomorrow's Eurozone CPI is the mostly highly anticipated piece of data from the region this week. We know that inflation is the European Central Bank's top priority but despite all of stimulus provided last month, CPI growth is expected to remain anemic. According to the economists surveyed by Bloomberg, annualized CPI growth is expected to hold steady at 0.5% with core price growth remaining unchanged at 0.8% in the month of July.  Considering that the ECB has a 2% inflation target, these numbers indicate that price pressures are far short of desirable levels.  Based on CPI alone, the ECB should be actively discussing ways to increase stimulus but combined with U.S. dollar strength and the geopolitical tensions that could directly affect the Eurozone, the EUR/USD has come under significant selling pressure.  If the CPI report reinforces everyone's belief that the ECB will ease again, the currency pair could test its November low of 1.3295.  German retail sales and unemployment are also scheduled for release on Thursday and their outcomes will affect EUR as well. 

GBP: The One Chart that Explains GBP/USD Weakness

While a large part of the sell-off in GBP/USD today can be attributed to dollar strength, sterling traders should also watch the 10-year Gilt and Treasury yield spread carefully.  The following chart shows how closely the currency pair tracked the 10-year UK-US yield spread.  If the spread continues to fall, so will GBP/USD.  Stronger U.S. data and the end of Quantitative Easing is beginning to drive U.S. yields higher at a time when a lack of hawkishness is keeping pressure on U.K. yields. Consumer confidence is scheduled for release tomorrow along with Nationwide house prices. While these reports are important, the main focus for the U.K. this week will be Friday's manufacturing PMI index.  

USD/CAD Climbs to Fresh 1 Month Highs

All three of the commodity currencies extended their losses today on the back of the rally in the U.S. dollar and decline in commodity prices.  Mixed inflation data from Canada and a rebound in New Zealand building permits failed to lend support to their respective currencies. In the month of June, industrial product prices fell 0.1% but raw material prices rose 1.1%.  Although inflation in Canada is ticking upwards, the central bank is still widely expected to keep monetary policy unchanged.  Even if they decide to raise rates in the future, it will most likely be after Fed tightening.  Over the past month, we have seen strong gains in USD/CAD.  A large part of the rally was driven by a shifting yield spread but short covering also contributed to the move because according to last week's CFTC IMM report, CAD shorts were at their highest level in 17 months.  Meanwhile building permits in New Zealand rose 3.5% in the month of June after falling -4.4% in May.  Unfortunately NZD received very little support from the news because of greater problems in other parts of the economy. The Australian dollar actually experienced the steepest slide.  No data was released last night but building approvals, private sector credit and import prices are scheduled for release this evening.  Based on the recent price action of the commodity currencies, further losses are likely.

USD/JPY Extends Gains, Japanese Data Weakens

The Japanese Yen fell to a 1 month low versus the U.S. dollar today and while the gains can be largely attributed to dollar strength, weaker Japanese data also dragged the currency lower.  Industrial production fell -3.3% in the month of June, more than two times worst than expected.  Over the past week, we have seen a turn in Japanese data that points to weakness in the second quarter.  The drop in industrial production follows a pullback in the manufacturing PMI index and overall household spending. Japanese businesses clearly expected a more significant recovery in demand.  Last night's industrial report could prompt a further downgrade of Q2 GDP forecasts. The case for another round of easing from the Bank of Japan is growing but the central bank will want to see how the economy performs in the third quarter before taking action.  However if economic data continues to weaken, traders will mostly reload their long USD/JPY positions in anticipation of additional action from the central bank.  Labor cash earnings, housing starts, and the Ministry of Finance's weekly portfolio report are scheduled for release this evening but risk appetite should continue to drive Yen flows.