Dollar Rides High into FOMC, 3 Things to Watch Next Week

• Dollar Rides High into FOMC, 3 Things to Watch Next Week
• EUR: Plan B for Greece?
• GBP: Busy Week Ahead
• CAD: Lower Oil Offsets Stronger House Prices
• Fresh 4-Year Lows for NZD/USD
• AUD: RBA Minutes Next Week

 Dollar Rides High into FOMC, 3 Things to Watch Next Week

The U.S. dollar is riding high into next week's Federal Reserve meeting.  Over the past month, the greenback appreciated strongly versus most of the major currencies. It is up more than 3% against the Japanese Yen, Australian and New Zealand dollars and we are looking for additional gains ahead of Wednesday's announcement.  The U.S. economy is gaining momentum after a slowdown in the first quarter and according to the latest economic reports, producer prices and consumer sentiment as measured by the University of Michigan index is on the rise.  This is on top of the increase in wages, improvement in job growth and pickup in retail sales. All of these reports harden the case for liftoff.  No one expects the Fed to raise interest rates next week but here are the 3 main things that we will be watching for:
 

1. Guidance - Janet Yellen and the Fed have a choice to make - they can either remain elusive saying that a timing of a rate hike is unknown and data dependent or they can prepare the market for tightening in September by preannouncing a move.  The last time we heard from the Fed was in April, it was under the backdrop of a weakening economy.  At the time, the central bank acknowledged the loss of momentum but indicated that it would be temporary. Back in March, they dropped the word patient from their monetary policy statement and said that a rate rise any meeting afterwards is possible but she stressed that no patience does not mean impatient.  This time around, we expect Yellen to say that any meeting from June forward is in play for a rate hike.  The key is whether they are growing impatient and the answer to that will depend on how much confidence they have in their outlook for the economy and the amount of flexibility that they want moving forward.
2. Economic Projections - The second focus will be on the central bank's latest economic projections.  Back in March, the Fed was very optimistic but as we now know, the economy slowed materially in the first quarter.  Many banks have lowered their growth forecasts since then and there's a reasonable chance that the Federal Reserve will do so as well. At the time, the Fed funds rate forecast was also higher because some policymakers felt that a rate hike in June was possible.  However whether these changes have a significant impact on the dollar or market expectations will depend on how much Yellen downplays these changes. If she stresses that they are temporary and we think she will, the market may overlook any reductions.   
3. The Votes - The latest decision by the central bank to keep interest rates unchanged was unanimous. In fact, there have been no dissenting votes among the members of the FOMC in the past 3 meetings, the longest stretch since 2011. With the economy improving, we could see a hawk like Jeffrey Lacker vote in favor of raising rates.  Throughout 2012, he had no qualms about going against the majority. If even one member of the FOMC votes for tightening, it will help the dollar.

EUR: Plan B for Greece?

Based on the price action of the euro, we are starting to think that investors either want Greece to default or they no longer care about the risks. Euro traded higher versus the dollar and continues to hold the 1.12 level.  The Greek debt discussions are not going well.  On Thursday, the IMF walked away from the negotiation table.  On Friday, the technical talks between Greece and its creditors ended with the country refusing to accept any pension or wage cuts.  As a result, there are reports that Eurozone officials are now looking at what would happen if Greece defaulted on their loans, which they view as an increasingly likely scenario.  We already discussed the near term ramifications of Greece missing the June 30th payment deadline (see this article) but a default would have more dramatic ramifications for the financial markets and we believe that EUR/USD traders are underestimating the risks.  The sharp rise in Spanish and Italian bond yields on Friday gives investors a taste of what could be in store. The spread between Spanish and German 10 year yields hit its highest level in a year and there's no doubt that this reflects the bond market's concern about what a Greek default and possible Grexit would mean for Spain, Italy and Portugal.  Greek debt negotiations remain in focus next week with little in the way of market moving data outside of the German ZEW survey.

GBP: Busy Week Ahead

The main focus will be on the U.S. dollar next week but there's also a lot of event risk for the British pound.  The Bank of England will release the minutes from their most recent monetary policy meeting.  Given that data was mixed going into the rate decision, chances are policymakers will remain divided on whether rates need to be increased this year. While they may be undecided, UK inflation, employment and retail sales data will help investors solidify their expectations.  Economists are looking for stronger data all around but we are skeptical especially on job growth because the PMIs reported lower employment growth in the service and manufacturing sectors. GBP/USD traded strongly on Friday, extending a rally that has lasted for the past 6 trading days. Resistance in GBP/USD is at 1.66. We are also watching EUR/GBP - if it drops to 0.7150, it could be a good level for a long entry.

Fresh 4-Year Lows for NZD/USD

For the third consecutive trading day NZD/USD has fallen to 4 year lows.  Last night's decline in the business PMI index from 51.7 to 51.5 validated the Reserve Bank of New Zealand's decision to cut interest rates this year.  The RBNZ warned us that there could be another round of easing if the economy does not improve so investors will be watching the data carefully.  Interestingly enough, next week's GDP report may not hurt NZD.  With retail sales rising strongly in Q1 and the trade balance turning from deficit to surplus, growth in the first quarter could beat expectations.  However the RBNZ is worried about future and not past growth, which they believe will be threatened by a strong currency. So the market may not make too much of the report.  The Australian and Canadian dollars also traded lower even though Canadian house prices rose more than expected. This weakness has to do with oil prices which dropped 1% today.