The search for a fundamental safe haven is likely to get even more difficult this week with the Fed rowing back from any hawkish talk while the ECB is set to cut interest rates in a desperate attempt to ward off any further tightening of monetary conditions. The net outlook still favors dollar appreciation as the least ugly currency over the next few weeks while the U.S. economy is likely to prove the most resilient in global terms. Buying dollar dips against all major currencies following the Fed meeting looks the best strategy, with EUR/USD a sell on any move to the 1.32 area.
The Federal Reserve last met following the very strong payrolls data for February amid evidence of a strong rebound in the economy. There was a slightly more hawkish undertone to the meeting as markets yet again pondered a great rotation out of bonds.
Since then, there has been one-way traffic and it has all been against the Fed hawks. The March payroll data was much more disappointing with estimated payroll growth of 88,000 following the revised gain of 268,000 the previous month. Looking at the data releases for April as a whole, 27 major economic releases have been weaker than expected while 10 were stronger.
Despite some marginal progress in alleviating some of the sequester effects, there has still been an underlying tightening of fiscal policy as spending cuts gradually come into force. The prospect for a tighter fiscal policy will increase the underlying burden on monetary policy and make it even more difficult for the Fed to taper bond purchases.
International considerations have also increased concerns surrounding the economic outlook with evidence of deteriorating conditions within the eurozone and major unease surrounding the Chinese outlook as shadow banking helps trigger a severe credit crunch.
Fed hawks will remain very uneasy surrounding the medium-term implications, but it will be virtually impossible to sell the message of any policy tightening at this meeting.
The tight coterie surrounding Chairman Bernanke and Vice Chairman Yellen are likely to remain firmly in control of the situation. There could also be the potential for increased talk of an even more aggressive policy stance if the economy falters.
Less than 24 hours after the Federal Reserve decision, the ECB will announce its latest policy decision. The rhetoric from key officials has been notably more dovish over the past two weeks. There will certainly be voices of dissent, but the recent survey evidence is likely to have convinced a majority that the ECB must take further action to help defend the peripheral outlook.
It would certainly be extremely damaging to build up market expectations of a rate cut and then disappoint them. The most likely outcome looks to be a cut in the benchmark report rate to 0.50% from 0.75% with the promise of further action to boost credit availability. The ECB will have the nuclear option to sanction negative deposit rates, but they are again likely to shy away from such action. If they do resort to negative deposit rates, look for massive Bundesbank dissent and a plummeting euro.