What Will the Fed Do This Week?

Market Drivers July 28, 2014
CNY Industrial Profits 17.9% vs. 8.9%
Markets slightly lower on geopolitical concerns
Nikkei 0.46% Europe 0.11%
Oil $101/bbl
Gold $1305/oz.

Europe and Asia:
CNY Industrial Profits 17.9% vs. 8.9%

North America:
USD Markit PMI Services 9:45
USD Pending Homes 10:00

The currency markets were extremely quiet on the first trading day of the week with most majors essentially at a standstill amidst summer doldrums and no economic data. Both the Asian and European calendars were barren today with only the Chinese Industrial profits on the docket which increased 17.9% versus 8.9% the period prior.

The US calendar is also very quiet today with only Pending Homes and Markit PMI Services gauge on the schedule suggesting that trading may be subdued all day long.

Although the start of this last week of July is following the typical somnolent summer trading path, price action could heat up considerably as we move towards Friday. On Wednesday the FOMC will meet and although this is expected to be a relatively routine meeting for the Fed with press conference afterward, markets are starting to speculate that some of the more hawkish members of the committee will press for a tighter schedule to raise rates.

Over the weekend, the widely followed Fed watcher Jon Hilsenrath of the WSJ noted that with QE coming to an end, this week's FOMC meeting could kick off an earnest debate about the timeline for rate tightening. For now Fed Chair Janet Yellen has been consistently noncommittal about the schedule for normalization of monetary policy, stating that the Fed remains data dependent. However, if this Fridays NFP proves to be another positive surprise the pressure on the Fed to tighten will ratchet higher.

The dollar so far has been relatively muted, as currency traders await the next policy move, but it does appear to be like a coiled spring and any hint towards tightening by the Fed could unleash a strong dollar rally as markets begin to adjust for interest rate expectations.

The one currency that is already starting to fold against the greenback is the euro as geopolitical tensions, slowdown in economic activity and easing of central bank reserve diversification flows have all combined to push the unit below the key 1.3500 level. Many of Wall street majors banks including Goldman Sachs and Morgan Stanley have turned bearish on the single currency with consensus now pointing towards 1.3000 as possible long term target.

However, market sentiment may be getting ahead of itself. If the Fed statement remains essentially unchanged this week, the euro could see a short covering rally and pop above the 1.3500 figure once again, despite the negative economic outlook.