As we had expected, the much anticipated FOMC statement provided no really new information. So without this guidance Forex markets have been drifting aimlessly. EURUSD traded between 1.3640 up to 1.3720 while cable chopped around 1.5880 and 1.5940. The key take-away from the FOMC accompanying statement was that the moderate recovery in growth was insufficient to support any meaningful improvement in the labor markets. Given this analysis we suspect that the $600bn QE2 asset purchases will go to the full duration (June expiry). In the Asian session, equities were mixed yet Shanghai's index was able to shake its recent trend (consistent with sudden rise in the Chinese 7-day repo rate) and climb 1.48%.
 
In New Zealand, the RBNZ held the offical cash rate steady at 3.00% as was broadly expected. The accompanying statement acknowledged that growth has underperformed expeecations stating Domestic economic activity was weaker than forecast through the second half of 2010 yet Forward indicators of activity have firmed somewhat... Trading partner activity continues to expand, and New Zealand's export commodity prices have increased further. Accordingly, the RBNZ expects interest rates are likely to increase modestly over the next two years. NZD reacted justifiably, trading up to 0.7720 as the NZ 2y swap rate moved about 5bp higher to 3.90%.

Our base scenario is that interest rate differentials will continue play a major role in FX pricing throughout 2011 and central banks leaning toward further tightening will encourage further longs in their corresponding currencies. It is this analysis that has helped EURUSD trade higher; interest rate expectations continue to be driven higher by events in the EZ (German vs. US yield spread further widen today) while the FOMC leaves us with no doubt that ultra loose monetary policy will remain as labor markets remain soft (unless core inflation unexpectedly reverses).

In a surprise move this morning, ratings agency S&P downgraded Japan one notch to AA-. USDJPY was motionless at 82.20 for most of the Asian session, but instantly ripped through the critical 83.10 level before retracing slightly (EURUSD & GBPUSD taking the burden of the offered USD). The obvious reasons for the rating cut have been cited as weak growth, shifting demographics, and deflation. However, with Japan's large domestic saving rate and small percentage of foreign owned JGBs, the risk of a sovereign credit crisis is remote. But we do suspect further JPY weakness as its safe haven status erodes and interest rate differentials widen.

As a final note, BoE MPC minutes released yesterday clearly indicated that member s have shifted to the more hawkish side of the inflation argument. MPC member Weale joined Sentence in calling for a 25bp hike making the vote now 6-2-1 (Posen continued to vote for the continuation of the QE program). While the members clearly had no chance to see Tuesday's horrific GDP release, we suspect that the erosion in growth due to inclement weather was a one off (and the -0.5% print, an underestimation) so expect growth to rally in Q1 2011. This will keep members focused on the stubbornly elevated inflation data. On the docket today markets will be focused on the US durable goods number and a slew of ECB speakers; watch for any updates on Europe's financial rescue mechanisms.
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