by Darrell Jobman, Editor-in-Chief TraderPlanet.com
The dollar pushed through Euro support close to 1.3780 on Tuesday and extended gains to 1.3730 ahead of the Federal Reserve decision. The dollar initially weakened after the FOMC statement, but bounced back to 1.3740.
As expected, the Federal Reserve left interest rates on hold at 5.25% following the latest FOMC meeting. In the statement following the decision, the Fed stated that inflation was still the pre-dominant risk, especially with doubts whether underlying price pressures would moderate as expected.
The Fed also stated that downside risks to growth had increased somewhat with on-going adjustment in the housing sector. The statement overall was slightly softer than the previous meeting, but it was tougher than had been expected. Markets have also already priced in lower interest rates this year which should provide some degree of protection from aggressive dollar selling.
The US labour cost data was stronger than expected with an increase of 2.1% in the second quarter. After an upwardly-revised 3.0% the previous quarter, the annual increase rose significantly to 4.5%. Inflation concerns may offer some dollar support, but US asset prices will not perform strongly if markets fear a slowdown in growth while the Fed feels unable to respond due to persistent fears over inflation.
The dollar was unable to push back above the 119.0 level on Tuesday and drifted back to 118.50 ahead of the FOMC decision. A Wall Street retreat after the Fed decision pushed the US currency to lows of 118.0 before gains to 118.80 in very choppy trading.
The Japanese government left its assessment of the economy unchanged in the latest monthly report while a confident stance from Bank of Japan Governor Fukui maintained the potential for an August interest rate increase, although this decision is likely to remain open. The IMF increased its 2007 GDP growth forecast and stated that the yen was undervalued, but the impact was limited.
Yen moves are still likely to remain dominated by levels of risk aversion and stock market trends in the short term with the Japanese currency gaining support if there are renewed declines in equity markets. There is likely to be further short-term institutional dollar support below the 118.0 level with volatile trading liable to persist.
Sterling remained on the defensive during Tuesday with lows around 2.0190 against the dollar and 0.6715 against the Euro before a measured rebound in US trading.
The British Retail Consortium (BRC) reported that annual like-for-like sales growth slowed to a seven-month low in July at 1.2% which will maintain expectations over an underlying slowdown in consumer spending even though there were significant distortions caused by adverse weather conditions.
There has been a gradual erosion of UK interest rate expectations over the past week with reduced confidence that rates will be increased to above 6.0% and this is undermining Sterling support given the amount of further tightening previously priced in.
In this context, the Wednesday Bank of England inflation report will be very important for interest rate expectations and the currency will be very vulnerable if the report hints that rates have peaked. The central bank should continue to emphasize inflation risks which would provide some short-term Sterling protection.
The Swiss currency weakened to 1.1970 against the dollar and 1.6450 against the Euro on Tuesday before finding fresh buying support. The franc gained after Wall Street edged weaker following the Fed interest rate decision, although these moves were subsequently reversed in choppy trading.
The Swiss unemployment data will be watched closely on Thursday and a lower rate would reinforce confidence in the economy, although international considerations are likely to remain dominant. The underlying tightening of credit will provide important Swiss currency protection.
The Australian dollar resisted a further test of support below the 0.85 level against the dollar and strengthened back to 0.8590 in local trading on Tuesday before drifting weaker again. Markets are expecting a further Reserve Bank interest rate increase on Wednesday local time which will underpin the currency in the very short term. The bank could, however, decide to wait for further evidence and hold rates steady which would result in a sharp Australian dollar decline as an increase has been priced in.
International trends will also remain very important and the Australian dollar will tend to gain support if there is a sustained rally in global stock markets. Nevertheless, risk aversion is likely to remain higher given the underlying credit tightening which is likely to curb buying support.