Fed Preview - Will Powell Help or Hurt the US Dollar?

The US dollar saw strong gains in the month of April and while the greenback dipped against most of the major currencies on the last trading day, buyers slipped in quietly towards to stabilize the currency. The latest US economic reports were good with consumer confidence and pending home sales rebounding. House prices even ticked higher year over year. Improvements such as these makes handicapping Wednesday's Federal Reserve monetary policy announcement particularly difficult. On the one hand we know the Fed has no plans to raise interest rates against this year but there's been widespread improvements in the US economy since the last meeting and stocks are at record highs.

We don't expect the FOMC statement to be a big market mover because it is too soon for any major changes to the policy language. Fed Chair Powell on the other hand could excite the bulls if he recognizes the improvements in the economy. Taking a look at the table below, since the March meeting job growth, retail sales, manufacturing activity and inflation ticked higher. The US economy grew 3.2% in the first quarter, which was significantly stronger than the market's 2.3% forecast. While trade and inventory take most of the credit, consumer spending also picked up in March. The persistent strength of the labor market and the continued rise in stocks should keep demand supported. When the Fed last met, they lowered their economic projections and shaved their rate hike forecast. However at the time, Powell described the economy as being in a good place. There has been no talk of rate cuts by US policymakers and some even suggested that if data improves a hike would be back on the table. Yet Fed fund futures are pricing in a 67% chance of easing this year, which is a big divergence from the central bank's guidance.

How the dollar reacts to FOMC will be a question of how Powell views recent data improvements - are they a sign that the prior slowdown is temporary or should they be overlooked in favor of low inflation and sluggish global growth? If Powell recognizes data improvements and downplays the possibility of easing, the dollar will extend its rise with USD/JPY heading back to 112. If he stresses the need for patience and emphasizes the risks to growth, we will see a sharper slide in USD/JPY and a short squeeze for other major currencies.

The best performing currency today was sterling, which shot higher against all of the major currencies. GBP/USD blew past 1.30 resistance on the expectations that there will be more relief than worry at Thursday's Bank of England meeting. We are skeptical and worried about a correction in the next 24 hours. Not only could the US dollar trade higher on FOMC but UK manufacturing activity weakened in April according to thee Confederation of British Industry so PMI could be softer as well. Meanwhile the recovery in EURO was justified by stronger EZ GDP, German labor market and inflation numbers. Its been some time since we've seen back to back improvements in European data so if Powell's optimism falls short, EUR/USD will be a particularly attractive currency.

The commodity currencies were mixed today with the Australian and New Zealand dollars trading in opposite directions despite softer Chinese PMIs. AUD ticked lower while NZD marched higher. Given the softness of the Chinese economy and the cautiousness of the RBA, the risk is to the downside for tonight's Australian manufacturing report. New Zealand's first quarter employment report is also scheduled for release and all signs point to slower job growth. Not only is the RBNZ dovish but the employment component of the PMIs fell and Manpower reported weaker labor market conditions. Tonight will be a big night for both currencies. Last but not least, Canada's economy contracted in February but USD/CAD traded lower on the back of US dollar weakness and higher oil prices.