There is a creeping sense of risk-aversion ahead of the Fed's policy statement this afternoon. Asian stocks stepped in to the red after further anecdotal evidence of a cooler economy in China. The negative tone prompted a reduction in demand for riskier assets and has bolstered demand for the Japanese yen. Meanwhile the entire debate over fresh stimulus measures at Tuesday's FOMC meeting has gone full circle with the market seeming to regret it had punished the dollar as hard as it did over the past week.

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U.S. Dollar - At its last meeting the Fed quickly concluded that the economy was no longer expanding at a strong pace and deliberated what could be done. The minutes of that meeting reflect the buck being passed from member to member, none having any concrete ideas on what to do. Today's statement should reveal certain specific ideas but in all likelihood it's too early to expect the Fed to wade back in with a specified timetable of bond purchases. Only two meetings ago the members tossed around the notion of an exit strategy and in the face of an amelioration of the expansion, it would be a tough call to go the whole hog and announce that now is the time to buy more bonds.

The dollar index is up around 0.6% already this morning. Investors have covered short positions with the latest initiated on the spur of the moment following the July employment report on Friday. The bigger loss of jobs than was forecast ushered in the strongest price for the euro in three months as investors were too quick to conclude that the Fed was now duty-bound to announce fresh measures. In reality the data was no different than anything seen in recent weeks depicting the modest expansion that the Fed said it now recognizes.

Japanese yen -The yen rallied significantly against the pound, euro and Aussie dollar while remaining static per U.S. dollar at ¥85.94 after the Bank of Japan left monetary policy unchanged on Tuesday. Signs of mild weakness in Chinese data helped tip investors towards a risk-off day. The July trade surplus of $28.7 billion was larger than expected thanks to a combination of a higher level of exports, which grew by 38% year-over-year, and a dip in imports. The nation sucked in 22% more goods than at the same time a year earlier but the volume fell short of forecast. Coupled with data showing that home prices grew by no more nor any less than the previous month, investors were sharp to conclude that a Chinese slowdown had continued, which weighed on other high-yielding Asian currencies. Feeling the benefit at the other end of the pressure valve was the Japanese yen where some investors continue to express disappointment that the Bank of Japan is keeping rather quiet about its currency's rise given the risk it poses to exporters.

Aussie dollar - The Aussie has slumped all the way back to 90.85 U.S. cents on Tuesday as domestic data failed to counter the notion of a cooler Chinese economy. The National Australia Bank index of both business conditions and confidence slipped with the latter reaching its lowest in 14 months. With evidence of the impact of tighter domestic monetary policy and a lack of positive news about China, the Aussie is suffering a minor downfall after it attracted plenty of recent interest from investors hoping for ongoing global growth. The Aussie slipped to ¥78.15 against the Japanese yen.

Canadian dollar - The Canadian dollar continues to feel the double-whammy of rising risk aversion and a recovery for the greenback. Declining commodity prices are somewhat of a hindrance today also as investors sell crude oil futures back towards $80 per barrel in the face of tepid growth. The unit slid to 96.54 U.S. cents this morning.

British pound -The pound was knocked off its perch this morning by the rampaging dollar. Having touched almost $1.6000 on Friday, dealers are falling over each other to lighten the load on Tuesday with the pound skidding to $1.5725. Investors are also mulling a couple of pieces to the economic jigsaw released earlier. The Business Retail Consortium's retail sales reading for July saw same store sales advance 0.5% over the June reading. Last month the data was unusually strong and painted a glowing report for the economy. Today's data is a typical antidote, which is not helping the pound out today. Elsewhere a RICS survey unexpectedly depicted a net balance of surveyors and estate agents reporting weaker rather than stronger home prices throughout July. An 8% dip compares to an expected 5% gain and is the first downturn in a year. The pound lost ground to the euro which rose to buy 83.50 pence.

Euro - The euro is today in the process of extending a loss against the dollar and has so far reached an intraday low of $1.3125. It's not necessarily an iron-clad case of euro weakness today. Rather it's a story of dealers warming to the dollar as they attempt to gauge the likelihood of what the Fed might do later on Tuesday. The worst case scenario would be an all-out war on deflation involving a further round of treasury and mortgage bond purchases. Sentiment in favor of the euro reached an extreme in light of Friday's report that the U.S. had lost more government jobs than was expected. But a closer analysis of the data doesn't confirm anything the market didn't already know and to that degree lessens the likelihood that the Fed will make any major move this month. It might, however, outline conditions under which it will move and it might portray its likely course of action. Until now, the dollar has cheapened for fear that the recovery is weakening and that the economy needs a further shot in the arm. With the market concluding in the cold light of day that the probability is now lower, it's the euro that's lost a chunk today.

Andrew Wilkinson

Senior Market Analyst       

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