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•US Dollar Weathers Risk Appetite, Looking Ahead to the FOMC Decision
•Japanese Yen Bolstered by an Increasingly Optimistic BoJ and Stricken Market Sentiment
•British Pound Steady through Mixed Data but What About Tomorrow's Quarterly Policy Report?
•Canadian Dollar Suffers a Particularly Sharp Decline Amongst an Already Week Commodity Bloc

US Dollar Weathers Risk Appetite, Looking Ahead to the FOMC Decision
Some of the majors were experiencing significant levels of volatility through Tuesday's trade; but on the whole, the US dollar was itself relatively unchanged. Accounting for the exogenous influence of risk appetite, this stability becomes relatively clear. USDJPY fell nearly 140 points while USDCAD rallied another 130 points through its fourth consecutive daily advance. This divergence clearly highlights the influence of sentiment as the yen rallied thanks to its greater safe haven appeal; while the Canadian, Australian and New Zealand dollars all tumbled thanks to their exposure to risk appetite. In contrast, the benchmark currency was relatively unchanged in its highly liquid euro and sterling pairings.

Looking beyond the whims of investor confidence, the dollar would still find a significant round of data to absorb through the US session. Though typically overlooked by event-risk traders, today's productivity and unit labor cost figures for the second quarter have a deeper meaning for those fundamental traders that are trying to benchmark the pace of the US recovery and gauge whether it will return to a period of substantial growth before its major counterparts. Following on the heels of the disappointing breakdown of the GDP figures for the same period (the headline reading was better; but consumer spending and fixed investment data was certainly not supportive of a quick recovery), the Bureau of Labor Statistics reported a much greater than expected 6.4 percent jump in non-farm productivity and sharper 5.8 percent contraction in labor costs over the three month period. From a policy standpoint, this is promising data as it should keep inflation under wraps as officials try to slowly unwind its support of the market. Alternatively, for growth, the sharpest increase in efficiency in nearly six years was largely a side effect of mass layoffs. Such cost-cutting efforts merely reduce consumers' capacity and willingness to spend - sabotaging efforts to jump start growth.

Looking ahead to tomorrow, those looking for immediate volatility may find better opportunity in the event risk on deck. It is worthwhile to take note of the monthly trade figure (as the shortfall contracts in response to fading domestic and foreign demand) as well as the monthly budget deficit as funding the stimulus becomes a greater concern. Altogether though, the FOMC rate decision represents top event risk. There is very little chance that the central bank will change its benchmark lending rate or even alter the size and scope of their quantitative easing program. However, speculation can run on far less. Since data offered up a tempered pace of recession for 2Q GDP and the first downtick in unemployment in 15 months, the market has moved up its time table for the Fed's eventual turn to a hawkish policy stance. Without support from a more up-beat outlook for growth or dropping the promise of holding rates until mid-2010, this premium could quickly deflate.

Related Article: How should event-risk traders prepare for the FOMC rate decision?; What is at stake at August's policy meeting?

Japanese Yen Bolstered by an Increasingly Optimistic BoJ and Stricken Market Sentiment
The Japanese yen was the biggest mover for the day by a wide margin. This was instigated by not only a turn in risk appetite but also a round of promising forecasts from policy officials in the early Asian session. Few expected anything to come out of the Bank of Japan's (BoJ) rate decision. An overnight rate at 0.10 percent doesn't allow for further easing (at least not any reduction that would produce any economic benefit) and un-orthodox policy methods are both over-extended and increasingly subject to political scrutiny ahead of the national election. However, forecasts are fair game and exactly what speculators prefer to work with. BoJ Governor Shirakawa reaffirmed the forthcoming recovery would be weak; but that it was nonetheless on track with exports and industrial production improving. Offering its own projections, the Cabinet Office kept its assessment steady after three consecutive upgrades by saying economic conditions are difficult but that growth was picking up recently.

Realistically, no matter how optimistic the government and central bank are on their outlook (they naturally have to be cheerleaders for their own economy); the market would hardly buy the yen in droves on such prospects alone. Therefore, the real fuel for the currency was sentiment. Equities suffered their biggest slump since July 7th while commodities pushed new lows of their own. There were many contributing factors to this downshift in optimism; but the two largest components were disappointing data from China and warnings from a US Congressional Oversight Panel. China is considered the leader of the world's economic recovery; so today's reports of a sharp drop in 2Q exports and new lending undermines the broader outlook. In the US watch-dog was put in as a second opinion on the effectiveness of the TARP program. It is clear that confidence is still fragile in speculative endeavors; so warnings that bad assets could still swamp the financial system - and especially small banks who can't access funds - reminds investors that stability is still fragile and very much a condition born of intervention.

British Pound Steady through Mixed Data but What About Tomorrow's Quarterly Policy Report?
While broad market themes would dominate price action for most of the currency market, the British pound would take in a significant round of scheduled event risk on its own. Released well before the open of the London session, the July readings for the RICS House Price Balance and BRC Retail Sales Monitor both reinforced hopes that the United Kingdom would expand through the current quarter. The proprietary spending indicator reported a 1.8 percent increase in same-store sales over the year as consumers. At the same time, the housing sector inflation gauge rose to its highest level in two years (with a -8.1 percent balance) to walk the fine line of signaling a recovery for the battered sector and threatening an untimely return of inflation. Looking ahead to the next 24 hours, event risk really starts to pick up. The jobless claims change is likely the greatest threat to short-term volatility as a growth indicator; but the Quarterly Monetary Policy report has the greater scope. After the MPC announced it was expanding its bond purchasing program just last week, market participants will want details.

Canadian Dollar Suffers a Particularly Sharp Decline Amongst an Already Week Commodity Bloc
Though the broader commodity bloc was under pressure, it was the Canadian dollar that took the lead on dramatic declines. A direct correlation to crude no doubt helped accelerate the decline by producing new lows for the month. However, data would also have its impact. July housing starts came in under expectations and a separate report revealed a 52 percent increase in bankruptcies in the year through June. How extensive will the country's first recession since 1992 be? We will gather a better sense of its extent with trade figures due tomorrow.

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Written by: John Kicklighter, Currency Strategist for