The EUR/USD countdown to the FOMC

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Sentiment on Asian equity markets is still cautiously ‘risk on’, but markets are in a wait-and-see mode ahead of the Fed policy decision later today. EUR/USD remained well supported and easily holds above the 1.29 mark. Also remarkable, of late, the Dutch elections were mentioned as a potential risk factor in Europe (to be honest we never really understood why). The pro-EMU parties had a clear victory, but the election is no big issue on the financial newswires anymore. So, the impact on EUR/USD trading will be limited.

Yesterday, all eyes in the market were on the ruling of the German Constitutional Court in Karlsruhe. Most analysts didn’t expect the court to block the start-up of the ESM (and thus also the implementation of last week’s ECB anti-crisis policy framework). The euro was well bid early in the session. There were some very wild swings at the time of the announcement of the ruling.

The EUR/USD spiked to an intraday low in the 1.2815/20 area, but this move was almost immediately reversed as the ruling didn’t bring any high profile obstacles to the new European crisis toolkit. EUR/USD filled offers in the 1.2900 area as soon as the details of the ruling became public. EUR/USD closed the session at 1.2900, compared to 1.2855.

Later today, there are only some second tier eco data scheduled for release in Europe. The most interesting feature this morning will be the Italian bond action. Expect the auction to go well. However, of late the impact from spreads/intra-EMU bond markets on EUR/USD was not that big. The cat-and mouse game whether Spain will apply for EU assistance will continue to create headlines but we don’t expect big news before tomorrow’s meeting of the EU/EMU Finance Ministers.

In the US, the calendar is thin too, with only the PPI data and the jobless claims. However, quite a wide deviation from consensus is probably needed to see a lasting and meaningful reaction of EUR/USD (and in other markets) just a few hours before the key Fed policy statement. Expect the Fed to set a substantial step to more policy stimulation.

Part of this is already discounted in the recent decline of the dollar. The details of the Fed communication will be important and a policy decision is always some kind of binary in nature. Nevertheless, given the strong language from Bernanke of late, we think that the Fed is more or less ‘obliged’ to make a substantial move. Otherwise it would hurt Bernanke’s credibility. It is also not a good time for the Fed to be a source of negative market volatility. So, the jury is still out, but we see a decent chance that the Fed will go far enough for the risk-on rally to continue. In such a scenario the dollar might see some further losses. At some point in the near future some consolidation/correction on the recent dollar decline is very well possible but for now we think that it is still too early to preposition for such a move.

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About:FX Empire Analyst - Barry Norman

Barry produces a private Daily Market Review newsletter that is distributed around the globe to over 25,000 subscribers and recently published a book on Options Trading that is available from amazon.com

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