After Obama induced USD selling, the Forex markets have failed to find a common theme and trading remains volatile. EURUSD has bounced around the 1.3660 to 1.3706 range while GBPUSD has been holding slightly above the critical 1.5720 support. Markets seem to be still digesting the oversubscribed EFSF offering, dismal UK GDP release and US Presidents Obama's sudden turn toward fiscal conservativism. In addition, today's event laden calendar has traders frozen in their tracks. The first issuance of EFSF bonds were in serious demand, with official orders standing at €44.5bn received vs. €5bn offered. On the one hand it illustrates the confidence investors have in the EU in its totality. But on the other hand to receive a decent yield over German bunds on triple-A rated paper is just a good deal. What savvy investors wouldn't take advantage of the trade? In the UK, GDP printed a dire -0.5% q/q vs. 0.5% exp. Not to flog a dead horse any further but the headline data and underlying inputs look as if economic activity in the UK is slowing significantly. From a fundamental standpoint we suspect that the weather related effect was even more then -0.5 erosion attributed (natural disasters are notoriously tricky to model) and we should see this reflected a decent recovery in Q1 2011. That said the technical picture is cloudy with a skew to further cable downside. The soft numbers combined with BoE Governor King's reiteration that the BoE MPC remains committed to low policy rates, has reignited opinion that the next hike would not be coming till Q4 2011. However, we suspect that today's BoE minutes will bring out the hawkish side of members (drifting towards Sentence's inflation fighting view) who are now faced with surging inflation data. It's important to mention they would not have a look at yesterday growth numbers.

The Norges Bank is scheduled to convene on today for the latest vote on Norway's monetary policy, but once again, it is expected rates will remain unchanged at 2.00%. Rhetoric from the central bank towards the end of last year suggests that further hikes are unlikely until the middle of 2011, and for now, we concur that a near-term hike is improbable. One of the key arguments against further tightening in Norway is the fragility of the Eurozone recovery and what that means for Norwegian exports. Nevertheless, with sentiment surrounding European stability on the rise in the new year, and Norwegian data since the last meeting being relatively strong, there is definitely scope for the central bank to start prepping the market for a hike in H1 this year. Our forecast is for the next rise of 25 bps to come in May.

As for the highlight of the day the FOMC meeting, markets are clearly focused on the accompanying statement. Its universally expect that monetary policy rate & the asset purchase program will remained unchanged. While the language referring to potential duration of the Fed's ultra loose monetary policy extended period will remain untouched and the current program of QE2 purchases ($600bn) to be completed as scheduled. There will be some general housekeeping with hawkish non-voters now getting a more prominent voice as the rotation makes them voter. Specifically, Philly Fed Plosser, now a voting member, has been very vocal about being unconvinced over the effectiveness of QE and will adamantly block any attempts to expand QE2. From the last FOMC meeting, minute's officials felt that the change in the outlook was not sufficient to warrant any adjustments to the asset-purchase program, and some noted that more time was needed to accumulate information on the economy before considering any adjustment. Given recent improvement in growth (including this week's GDP expected to hit 3.5% q/q), fall in unemployment rate and rise in inflation data has potentially increased the likelihood the members language begin to acknowledge the momentum. However, should the FOMC show no near term sign of concession, this will reinforce the markets view that the EUR / USD interest rate divide will continue to widen and be USD negative.
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