With a Federal Reserve monetary policy meeting and the non-farm payrolls report on the calendar this week, what is happening in the U.S. could have as much impact on the FX markets as the ongoing developments in Europe. We don't expect the Federal Reserve to make any specific mention of QE3 this week and the absence of any comments should be positive for the dollar. Along these lines, we also expect non-farm payrolls to rise above 100k, which would be good for risk and USD/JPY. Barring any massive collapse in the markets between now and Wednesday's FOMC meeting, there is a very good chance that the FOMC statement will contain virtually the same language as June.
Earlier this month when Fed Chairman Ben Bernanke gave his semi-annual testimony on the economy and monetary policy, he stopped short of mentioning asset purchases or Quantitative Easing. While the Fed Chairman made it clear that it is ready to act if needed, the challenge right now is figuring out whether the "loss of momentum in the economy is enduring." Unfortunately since the last monetary policy meeting in June, we have seen very little evidence of clear directionality in the U.S. economy. Without enough improvement or deterioration in economic data, policymakers will choose to forgo QE3 in August. The recent decline in European bond yields and rise in global equities also reduces pressure on the Federal Reserve to make any rash decisions.
The following table shows how the U.S. economy has performed since the last monetary policy meeting. As you can see, there have been improvements and deterioration. While retail sales fell for the third consecutive month in June, second-quarter GDP growth contracted less than expected and inflationary pressures stabilized. Existing, new and pending home sales declined in June but the data is not so bad when compared with the numbers that the Fed had on hand at its last meeting. There's no question that most of these economic reports show continued weakness in the U.S. economy but in the Fed's eyes, material deterioration needs to occur to warrant a third round of Quantitative Easing. The longer the Federal Reserve holds out, the more room there is for a rally in the dollar.
The September FOMC meeting will be a much more important. By then, we will have two more non-farm payroll reports and another retail sales report. With approximately 8 weeks between now and the September 13th monetary policy meeting, a lot could happen in the financial markets and in the U.S. economy. If QE3 was needed, Bernanke could still signal his plans at the annual Jackson Hole Economic Summit of central bankers in late August. Both the 2010 and 2011 Jackson Hole Summits were Bernanke's venue of choice for signaling a major change in monetary policy - in 2010, Bernanke delivered his infamous speech that tipped off the market that QE2 was on the way and in 2011, he expanded the FOMC meeting from 1 to 2 days to outline the details for Operation Twist. With very little consensus within the central bank, increasing asset purchases in 2 months instead of 2.5 weeks is far more realistic. By then, the latest FOMC forecasts would have been released, giving central bank officials a much better sense of how the economy is faring. Furthermore, the timing of the September FOMC meeting is perfect because Bernanke could use the Jackson Hole Summit to signal a potential change, make the adjustment in September and then answer questions at the regularly scheduled post monetary policy meeting press conference.
As for the non-farm payrolls report, the level of jobless claims is consistent with payroll growth in excess of 100k, which is what economists are looking for. Over the last 3 weeks, there were 2 weeks where the jobless claims number was at its lowest level since March 2008. Of course, claims are distorted this month by the annual auto plant retooling period but if payrolls do rise above 100k, USD/JPY will rally in relief.