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Expectations of how optimistic the Federal Reserve will be at its meeting today are dominating price action this morning. The combination of strong US employment data along with the Fed's pledge to keep monetary policy loose for some time does not appear sustainable. While we agree with consensus that Bernanke and co won't move on policy today and instead will remain in wait-and-see mode, we do think that the market will be over-sensitive to any Fed comments in its accompanying statement.

Bernanke won't host a press conference this evening as it is only a one day meeting, however, that won't stop markets over-reacting. Basically, if the Fed sounds more optimistic on the jobs outlook and economic progress that has been made recently this could push up the dollar and weigh on risky assets like stocks as it reduces the prospect of more QE. However, if the Fed remains cautious then this could cause the recent dollar rally to stop in its tracks which makes USDJPY particularly vulnerable.

It's a tough one to call. The Fed can't ignore the payrolls data and signs that the economy could continue to pick-up, but equally it most likely won't scrap the QE card entirely either especially since the jobs being created by the economy are traditionally in the lower paid sector that could thwart a consumer boom going forward.

The path ahead for the Fed will be a tricky one to navigate. Does it tighten policy in an attempt to bring oil prices down, after all gas prices are approaching $4 per gallon and the driving season is fast approaching. More QE could exacerbate this problem as the extra liquidity can seep into commodity markets and push up the price of oil. Americans hate high gas prices, so that should mean no more QE, right? Not quite. Some sectors of the US economy are completely reliant on lose monetary policy from the Fed including the housing market. Thus, it's unclear whether the US economy can stand up on its own two feet, so the likely course for policy action in the US is ultra-caution.

But what does this mean for the markets?  If we don't get a clear sense from the Fed if they are going to loosen or tighten going forward then expect recent ranges to persist  in EURUSD and GBPUSD. AUDUSD has been driven to a greater extent by the negative tone to economic news from China, but declines in this cross may start to slow after it breached 1.0580 - a major support level and the top of the daily Ichimoku cloud, which may attract some buying interest around the 1.0500 level.

However, we believe that even if the Fed keeps its cards close to its chest this will be positive for USDJPY. The Bank of Japan also met this morning and kept its policy position unchanged. The meeting was delayed leading to some speculation that the Bank would boost its asset purchase programme once more, however it didn't. This caused USDJPY to dip below 82.00on the disappointment, however it soon bounced back. BOJ Governor Shirakawa said at the post-meeting press conference that the Bank would monitor the economy to judge whether further easing is necessary. He also noted the external factors that could weigh on Japan's economy in future including high oil prices and a decline in global growth. Thus, monetary policy is likely to remain loose in Japan for some time, and stimulus programmes may even be expanded in the future. Crucially for USDJPY, the BOJ is likely to be more dovish than the Fed, which may lead to the cross seeing 85.00 in the coming months.

The focus has shifted in Europe from Greece to some stunning data in Germany. The ZEW index of investor confidence rose to its highest level in nearly 2 years in March. The expectations component, that measures sentiment 6-months ahead jumped from 5.4 in February (itself a multi-month high) to 22.3 in March. This suggests that momentum is building in Germany. Usually Europe's largest economy follows the trajectory of the US fairly closely, so signs of a pick-up in growth across the Atlantic are good news for Berlin.

However, this doesn't take away from the fact that sovereign concerns remain. This time the focus is on Spain, who is being forced into accepting larger fiscal deficit targets for 2012 at this week's Eurogroup meeting. Last month it defied Germany and said it was reducing its target for this year to try and protect growth. However, although the target has been reduced, Madrid's Eurozone peers wouldn't let it off that lightly and has pushed for a smaller deficit than Madrid proposed. But it does suggest that the tough fiscal targets across the currency bloc could be more malleable than some expect especially if growth shows signs of dipping.

The markets are acting as one would expect in the lead up to the FOMC. EURUSD gains are capped at 1.3150, while 1.3080 - the 55-day sma - s still holding as good support. Directional indicators are telling us nothing for the short-term, although the failure to break above 1.3180 yesterday suggests the pair could find it hard to gain traction on the upside. If we get an inconclusive Fed this evening then this cross may remain range bound with a slight bias lower.

Stocks are strong in Europe and even the banking sector is joining in the fun suggesting that the focus is on German economic strength not sovereign concerns today. The real trending markets are oil and also some of the Aussie crosses. The Cad and the Mex are looking strong since they are not only oil producers but also have strong links to the US economy. However, these pairs have moved strongly in recent days and may be in line for a pause. But for traders that love a tend they are out there, you just have to look a little harder than usual to find them.

Best Regards,

Kathleen Brooks| Research Director UK EMEA |

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