Dollar Dominates Post FOMC

Market Drivers October 30, 2014

Dollar continues to gain strength post FOMC
German unemployment better, but CPI worse
Nikkei 0.67% Europe .79%
Oil $81/bbl
Gold $1203/oz.


Europe and Asia:
AUD Import Prices -0.8% vs. 0.3%
CHF KOF Sentiment 99.8 vs. 99.2
EUR GE Unemployment -22K vs. 4K


North America:
USD GDP 08:30

Dollar continued to strengthen in Asian and early European trade after yesterday's surprisingly hawkish FOMC statement upended the currency market. The greenback gained ground across the board when the Fed unequivocally ended QE and stressed the improvement in labor market conditions while downplaying the disinflationary forces in the US economy. The relatively upbeat statement was not expected by the market and traders quickly adjusted their US interest rate expectations looking for a hike from the Fed by Q2 of 2015.

The FOMC meeting has proven to be the key trading event of the week as it revived the policy divergence theme which has been the primary driver of dollar strength. Although the Fed gave its ample wiggle room to delay any tightening action by keeping the "considerable time" language in its release, it became clear yesterday that US monetary policymakers are eager to commence the process of normalization after years of near zero interest rate policy.

The greenback should therefore continue to strengthen as long as US data remains positive. To that end today's GDP will be the first test of this thesis and if the numbers prove better than expected then the buck's rally is likely to extend.

In the meantime news out of Europe proved to be mixed with German unemployment improving but regional CPI data showing further downward pressures in prices. German unemployment declined another -22K versus +4K expected showing that labor demand in Europe's largest economy remains robust. The unemployment rate remained at 6.7%.

The news on the inflation front however was considerably less sanguine as disinflationary forces continue to persist. CPI turned negative in all the major German states declining by -0.2% in Saxony by -0.2% in Hesse and by -0.3% in Bavaria. The pressure on the ECB to act is rising, especially from the periphery countries where growth has ground to a halt, but Mr. Draghi still faces resistance from German monetary officials who oppose any extraordinary measures on ideological grounds.

Still, the the next ECB meeting could prove to be critically important if the central bank finally commits to a formal QE program. Such a move would confirm the policy divergence trade and push the EUR/USD below the 1.2500 figure.

In the meantime the focus today will turn to US GDP expected to print at 3.1% versus 4.6% the period prior. Any result above the 3% level will be viewed as dollar bullish as it will confirm that US continues to outperform in the G-7 universe. However, if the number is surprisingly low, doubts will creep back into the market and the buck will quickly reverse some of its recent gains with USD/JPY likely drifting back towards 108.0.