Ron Finberg's  Instablog

The Fed stated  “inflation to remain subdued for some time as resource slack dampens cost pressures.” Does this really mean  “inflation could skyrocket at any moment, but right we are really lucky to have too much supply to meet demand."
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Its true that these comments aren't new from the FED as seen from Jeff Pietsch's article comparing today to the August meeting.  However it does seem that the FED is banking on the fact that they are out of the woods for the short-term and can continue to follow their easing policy actions. <p>

The big question though, is not when prices will go up due to heightened demand, but whether the recent move in Gold has proven that commodity prices are taking high inflation for granted and therefore will rise before fundamentals support the move. 
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The answer may lie in the moves of energy prices.  Crude and Natural Gas prices have rallied as the dollar has fallen, but have tended to react more closely to fundamental releases than the metals.  If we begin to see crude take off and surpass $75 a barrel, even as inventories remain high, this may indicate that "resource slack" notwithstanding, high commodity prices and near term inflation will be arriving a lot quicker than the FED would like.

The main points of yesterday’s FOMC decision were as follows:

• As expected rates left unchanged at 0-0.25%
• Fed sees “leveling off” off economic slowdown
• Rates will remain low for a long time
• FED continues Treasury bond purchase program with end in October

Initially the USD strengthened on the report as Forex traders interpreted the news to be bullish for the economy as the FOMC gave a boost of confidence to US rebound. However, the combination of equities continuing their rally, and Treasury yields, that had spiked up earlier, trading back down on the realization that the FED won’t increase rates any time soon, the USD sold off as traders increased their risk appetite.

Inessence the FED did two things; they brought down the expectation for an immediate rate hike, and related that they are prepared to make changes in their quantitative easing , thus preparing an exit strategy.

My take is that the FED wants to keep rates low as a method of economic stimulus but appear that they have the foot on the brake to prevent inflation and decrease government intervention. Some analysts are of the opinion that the FED was purposely ambiguous and really did nothing because the only made a claim that they would end their Treasury purchases, but by stating that economic conditions warrant low rates, they open the possibility for additional monetary stimulus.

I believe that the FED’s actions do convey the beginning of an exit strategy, but,  inflation has been benign with weak retail sales and unemployment, so there is no reason for the FED to increase lending rates any time soon.

Based on this, I believe that the USD could begin to strengthen from the FED’s actions and that Forex traders will begin to view positive US economic news as a net positive for the USD. The belief is based on the fact that the FED has begun their exit strategy, and therefore we will to see additional policy statements that reflect a decrease of monetary easing if the economic rebound continues.

 

After Friday’s NFP results, Forex traders are claiming that the USD is back and that we may return to the trading pattern that “Good US News Will Lead the Dollar Higher.”  Yesterday, dollar momentum continued and the EURUSD traded below last Friday’s low of 1.4150 and hit a low of 1.4104, as stop orders were triggered when the pair broke below 1.4150.  Also assisting the dollar’s momentum was a weaker US equity market, and Conference Board employment numbers that were uninspiring.  The trading action shows that Forex traders are still buying the USD on risk aversion.
Currently, the pair has retraced some of its losses, but at 1.4170, is still treading below the 1.4200 figure.

At Go Forex, we mentioned on our Friday Morning Review that the dollar was positioned to strengthen on both better or worse than expected NFP results.  On the one hand, bad numbers would lead to USD and JPY “Safe Haven” buying, but a better than expected number could lead Treasury Yields to spike and dollar buying. 

We did believe though that if equity markets remained higher, it could kill the steam on the dollar rally.  That obviously didn’t happen and Forex analysts and bond traders are now pricing a 60% chance for a January 2010 rate hike.

At Go Forex we don’t believe this will happen because of the conservative nature of Central Bankers.  Case in point was the Bank of England’s expansion of their “Quantitative Easing” even on the heels of strong UK economic news.   Similarly, the BoC and RBNZ kept their rates at record levels and issued less than “hawkish” commentary (we predicted this in our RBNZ preview).  Secondly, Japanese retail sales numbers indicate that low interest rates don’t necessarily translate into inflation.  As long as inflation is tempered in the US, the FED won’t feel compelled to fight it. Additionally, Just a week and a half ago, the dollar had sold off following poor Q2 GDP results that indicated much of the US’s financial rebound was stimulus related and further government spending would be necessary.

The Falling Yen

Of important note though was the weakness in the yen.  It fell considerably against the USD from July lows of 91.75 to around 97.50.  Part of the move was caused by rallying stock markets, but the last move from just above 95.00 is a result of market sentiment that Japan’s interest rates are stuck at 0.1% and that the US’s rates will rise sooner than later. 

But, since yesterday afternoon, the yen has retraced much of it losses against most currencies though. Cause of the move has been attributed to weaker equity markets and a return to the "safe haven" currency, but there is also the strong possbility that the yen strength is due to Forex traders discounting the chances or global central bankers raising rates anytime soon.
 

Fed Tuesday, Wednesday

Unlike most FOMC rate decisions which are released on a Tuesday, this week there is a two day meeting so the policy decision will appear on Wednesday (this gives us another day to ponder what they will do).  Forex markets are hoping to hear commentary that the Fed believes the job market is stabilizing and growth for 2010.  As mentioned above, at Go Forex, we believe there are high percentages that the Fed will use conservative language and avoid any direct mention of when they will raise rates, thus possibly causing the USD to weaken, and Treasury Bond yields to drop. 

A WILD CARD though would be any mention of commodity prices.  With attention returned to Gold and Oil prices, there is a chance that the Fed may comment that they are monitoring commodity prices and their effects on the economy.   If this does occur, this could be understood as the Fed’s way of saying they are worried about inflation and a possible Rate Hike could occur in January 2010.

For Questions or Comments Regarding this Review Feel Free to Contact the Author at ron.f@goforex.com

***Disclosure: The author is a Forex dealer at Go Forex, a firm that is a Market Maker in Spot Forex Currency Pairs.