Talking Points

  • U.S. Dollar: Index Holds Upward Trend, FOMC To Maintain Current Policy
  • Euro: ECB Mandate Prohibits 'Massive Bond Purchases'
  • British Pound: BoE To Conduct More QE On Slowing Inflation

U.S. Dollar: Index Holds Upward Trend, FOMC To Maintain Current Policy

The greenback lost ground during the overnight session, with the Dow Jones-FXCM U.S. Dollar Index (Ticker: USDOLLAR) slipping to a low of 9,929, and the reserve currency may trade heavy throughout the North American trade as risk sentiment firms up. Indeed, the Federal Open Market Committee interest rate decision highlights the biggest event risk for Tuesday, and the developments coming out of the central bank are likely to spark increased volatility in the currency market as investors weigh the prospects for future policy.

Although the FOMC is widely expected to carry its current policy into 2012, we may see the central bank raise its fundamental assessment for the world's largest economy as the recovery gradually gathers pace. In turn, Fed officials may see limited scope to ease monetary policy further, and comments talking down expectations for QE3 should prop up the USD as the central bank looks to conclude its easing cycle. As the USDOLLAR maintains the upward trending channel from earlier this month, the recent weakness in the greenback is likely to be short-lived, and we should see the reserve currency continue to appreciate against its major counterpart as the fundamental outlook for the U.S. improves. However, Fed Chairman Ben Bernanke may keep the door open to conduct another round of quantitative easing as the sovereign debt crisis drags on the global economy, and the central bank head may preserve a dovish for monetary policy given the ongoing weakness in employment paired with the protracted recovery in the housing market.

Euro: ECB Mandate Prohibits 'Massive Bond Purchases'

The Euro fell back from an overnight high of 1.3236 as the European Central Bank argued against expanding its nonstandard measures, and the single currency is likely to face additional headwinds over the near-term as the fundamental outlook for the region turns increasingly bleak. ECB board member Jozef Makuch said the central banks' mandate prevents the Governing Council from carrying out 'massive bond purchases or Fed-style quantitative easing' while speaking in Bratislava, and encouraged the EU to address the 'many open issues' as investor confidence remains frail. As there appears to be a growing rift within the ECB, we are likely to see President Mario Draghi continue to target the benchmark interest rate to shore up the ailing economy, and expectations for lower borrowing are likely to drag on the interest rate, which could ultimately lead the EUR/USD to give back the rebound from back in January (1.2858). However, as the euro-dollar continues to trade above the 38.2% Fibonacci retracement from the 2009 high to the 2010 low around 1.3100, we may see a short-term correction in the days ahead, and the exchange rate may trend sideways going into the end of the year as market participation thins ahead of the holiday season.

British Pound: BoE To Conduct More QE On Slowing Inflation

The British Pound pared the advance to 1.5629 as the Bank of England struck a dovish outlook for monetary policy, and the bearish sentiment underlying the sterling may gather pace over the near-term as the region faces an increased risk of a double-dip recession. BoE board member Spencer Dale talked up speculation for more quantitative easing while speaking in London, and said that the slowdown in price growth will dictate future policy as the central bank sees an increased risk of undershooting the 2% target for inflation. As the fundamental outlook for the U.K. deteriorates, the GBP/USD may continue to give back the rebound from October (1.5270), and the sterling may weaken further in the following year as market participants expect to see additional monetary stimulus over the coming months.

--- Written by David Song, Currency Analyst