Tuesday afternoon the Fed announced it was keeping its balance sheet intact while changing the composition of said balance sheet by moving out of mortgages and into long-term Treasuries. This news triggered a strong surge in the Treasury complex, sending the September Treasury Bond to a new high for the year. The move by the Fed is designed to keep the pressure on long-term rates.
Stocks rallied from earlier lows but still managed to finish lower for the session. The action by the Fed triggered an intraday short-covering rally as traders felt relief the Fed did not take more aggressive action which would have sent a pessimistic tone throughout the markets.
The September E-mini S&P 500 remained rangebound for the seventh day, thereby setting up a possible volatile move over the short-run. Clearly the chart suggests a breakout to the upside over 1129.50 while a break under 1107.00 is likely to trigger a correction back to 1065.25 over the near-term.
December Gold finished higher as the Dollar weakened. Traders may have bought when the Fed failed to mention deflation in its statement. I still feel that gold and equities are competing for the same investment dollar which means they are likely to move in opposite directions over the near-term. Today’s better close could be a sign that equities are getting ready to break.
The U.S. Dollar gave back much of its earlier gains Tuesday afternoon after the central bank’s Federal Open Market Committee revealed a disappointing outlook for the U.S. economy.
The Federal Open Market Committee left interest rates unchanged as expected as well as a majority of its policy statement from previous sessions although it kept the language stating that inflation is “subdued” without specifically mentioning any issues with deflation. It also added that interest rates would remain low for “an extended period”.
The Dollar declined from its pre-report high as the Fed kept its balance sheet intact while changing the composition of said balance sheet by moving out of mortgages and into long-term Treasuries.
The FOMC vote was not unanimous, as Kansas City Federal Bank President Thomas Hoenig once again remained the lone hawk. The vote was not “bookended” by any doves as some had anticipated.
Before the release of the report that was much speculation as to how the Fed would address the issue of deflation. Concerns were being raised because if allowed to spiral out of control, deflation would be very difficult to contain, unlike inflation which the Fed usually battles with many of its monetary policy weapons.
The move by the Fed was enough to keep the pressure on interest rates while implying that the outlook for the economy remains rocky. Some analysts felt the move by the Fed was merely symbolic, but did send a strong signal that it was not going to stand on the sidelines doing nothing. Moving principal payments from the mortgage market to long-term Treasuries leaves the door open for the central bank to make more aggressive balance sheet moves at its next meeting on November 3 should the economy fail to improve.
While not actually disappointing investors with its actions, the Dollar did decline after an early morning surge triggered by speculation the Fed would act move aggressively to loosen monetary policy because of a slowing economy. Instead, the Fed may have acted more prudently with its action rather than create an aura of pessimism with unnecessary aggressive action.
Traders shouldn’t get too comfortable with the short-side of the Dollar despite the initial reaction because trading conditions suggest the Greenback is ripe for a rally due to increasing interest in safe haven assets. The next few days will give more clues as to whether the Dollar will rally or resume its recent decline. The first sign of weakness will be new highs in markets that have corrected the past two days, namely the Euro and the British Pound. The Euro and the Sterling both bounced back following earlier weakness, but not enough to reverse the developing downtrend.
Overnight a softer U.K. housing report overshadowed this afternoon’s U.S. Federal Open Market Committee announcement as falling house prices increased jitters in an already fragile economy.
Early in the trading session, a report from the Royal Institution of Chartered Surveyors said July house prices turned negative for the first time since July 2009. This report echoes earlier reports that showed a rising supply of houses for sale and decreased buyer interest. The return of a buyers market indicates the strong possibility of a softer housing market through at least the end of the year, leading to speculation of a double-dip recession.
Technically, after failing to follow-through to the upside following the penetration of a major Fibonacci retracement level at 1.5967 in two out of the last three trading session, the British Pound took out a main swing bottom at 1.5819. This move turned the main trend down on the daily chart. The chart pattern suggests that 1.5633 is the next likely downside target, followed by an uptrending Gann angle at 1.5400.
Concern about a slow down in the global recovery also pressured the Euro. Before the New York session opening, the Euro was trading on its low, threatening to turn the main trend to down on the daily chart on a move through the last swing bottom at 1.3119, a move which took place shortly after the NY opening.
Based on the range of 1.1876 to 1.3334, the chart indicates that this current break could turn into something substantial if investors decide to begin shedding risky assets. If this current break turns into a hard correction, the daily chart indicates that 1.2605 would be the minimum downside target. This price represents a 50% correction of the June to August rally.
Besides the start of downtrends in the Euro and British Pound, the shedding of risky assets such as gold and crude oil could be another sign that the Dollar is getting set to rally. Falling commodity and equity markets are likely to pressure the commodity-linked currencies. 
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