Friday's payrolls may have been a disappointment but the market is still uncertain as to whether the data represents an 'appreciable' weakening in the US economy. While the market did move towards pricing in a Fed ease in the aftermath of the jobs data there is a strong force of opinion that the Fed is unlikely at this stage to announce significant new policy measures.

This opinion appears to be based both on the notion that the Fed has no incentive to shock the market and on the view that despite the weak labour data, most other economic indicators continue to suggest expansion, albeit at a moderating pace. A consensus appears to be emerging that if the Fed does announce new measures at its policy meeting on Aug 10 that these are most likely to take the form of a reinvestment into the bond market of proceeds from maturing mortgage backed securities. Insofar as this was first flagged in an article in the WSJ last week it would not shock the market. It would have the additional advantage of not expanding the Fed's balance sheet any further at this stage so strictly speaking it would not be a new round of QE.

The dollar has traded in a choppy fashion this morning as the market grapples with the possibilities that face the Federal Reserve. Having flirted on Friday with the risk that the Fed could be on the cusp of easing again, the USD is a touch stronger this morning as the market recognises that the Fed may not at this point expand its balance sheet any further. While steady policy from the Fed this week could boost the USD a little further, the dollar could find the going tough near-term with German economic data suggesting that the ECB is far better positioned to carry on reigning in exceptional policy measures. This morning brought the release of better than expected German June trade data. The strong 3.8% m/m increase in exports massaged the idea that German's export led recovery is expanding nicely. Also worth noting is that the rise in imports was better than expected; a factor which may support growth elsewhere in the Eurozone. Later this week, German Q2 GDP will be released. Strong data would provide more fodder for the squeeze higher in EUR/USD.

USD/JPY continues to hover within spitting distance of the 15 yr low at 84.84. The outcome of the FOMC tomorrow has the capacity to break through this support; if a fresh round of easing is announced. Although the market remains wary of intervention from the MoF, such an outcome is still unlikely. With the obvious exception of the SNB, central banks and governments tend to avoid intervening in the fx market unless they have confidence that the fundamentals also support a change in the course of the currency. Given that the MoF have no control on the Fed and that this is the most clear influence on the USD at present, the chances of intervention from Japan is still unlikely.

Sterling has been relatively stable this morning ahead of the Fed and the release of the BoE's Inflation Report later in the week. Typically, Governor King has shrugged off the strength of CPI suggesting that inflation will be pressured lower by excess capacity in the economy. While it is unlikely that he will steer away from this line too much, stronger Q2 data suggested that excess capacity levels are a little lower than previously thought suggesting that the Bank may have to revise higher its inflation projections. Such an outcome is likely to be supportive for the pound.

Disappointing Australian housing and job ads data weighed on the AUD/USD overnight. Risk appetite fared better in European hours with stocks trading higher and AUD/USD pushing back to the 0.9205 area. However, conditions are subdued ahead of the FOMC tomorrow.

There are no key US or Canadian economic releases this afternoon.

Jane Foley

Research Director
+44 207 398 5024