Highlights

  •  Will the Fed Twist?
  •  BoE's MPC Minutes to provide insight on the QE debate
  •  Greek debt crisis remains in focus

Will the Fed Twist?

The past week's data releases continued to paint a bleak picture of the U.S. economic recovery. Retail sales in August stagnated (0.0% vs. prior 0.2%), regional Fed reports pointed to contraction in the manufacturing sector with September Empire manufacturing at -8.82 and the Philadelphia Fed index at -17.5 and weekly jobless claims climbed stubbornly higher to 428K from the prior 417K. The Fed has extended next week's FOMC meeting to 2 days in order to have adequate time to discuss monetary policy as several options are available to the committee. There should be no surprise in the target rate as the FOMC pledged to keep rates lows through 2013 and the committee will announce its decision on policy at the conclusion of the 2-day meeting on Wednesday September 21. With the rising CPI figures released this week - headline CPI rising to 3.8% y/y from the prior 3.6% and the core reading climbing to 2.0% from the prior 1.8% - it is highly unlikely that the Fed will announce QE3. The market is largely expecting the next move to be a shift in the duration of the Fed's current holdings which would be less bearish for the USD than outright asset purchases.

The so-called 'Operation Twist' (first seen during the Kennedy Administration in 1961) would see a flatter yield curve with the short end of the yield curve moving higher while longer dated yields move lower. Should this scenario play out, we would expect to see little impact on the dollar. A dovish policy statement is likely to see the dollar correct lower but the USD bias is higher while the dollar index remains above the top of the daily ichimoku cloud which is seen around 75.00.

The most visible impact in the FX markets may be seen in USD/JPY as the pair has been highly correlated to yields. A rise in short term Treasury yields would be supportive of USD/JPY and may see the pair advance. Japanese officials have been vocal about the strength of the yen and its negative impact on economic activity with the markets on alert for intervention. In our view, we anticipate the BOJ to stay on the sidelines ahead of the Fed decision.

BoE's MPC Minutes to provide insight on the QE debate

Earlier this week, the U.K. saw the release of a BoE survey on inflation showed that consumer expectations on inflation climbed to a 3-year high to 4.2% from 3.9% at the last quarterly survey in May. Retail sales (excluding auto fuel) for August declined by -0.1% m/m from the prior +0.2% while the y/y change fell by -0.1% (prior 0.0). The data underscored the BoE's dilemma of providing additional stimulus in the form of another round of QE to support the economy while inflation remains high.

BoE member Adam Posen said on Tuesday that the bank should expand its Asset Purchase Facility by a minimum of 50B pounds and as much as 100B pounds. He said, we should start with a minimum of 50 billion pounds in gilt purchases in secondary markets, tilted toward the longer end of the maturity spectrum, over the next 3-months. Additionally, MPC member Martin Weale noted that the risk of a double dip recession in the U.K. has increased. He said that more asset purchases were warranted if it seemed likely that inflation was going to undershoot. The dovish comments weighed on the pound with GBP/USD currently trading below the 100-week SMA that comes in around 1.5825. On Wednesday September 21, the Bank of England (BoE) will release its Monetary Policy Committee minutes. The minutes will give markets more insight into the ongoing discussions within the BoE on an additional round of asset purchases. If the minutes indicate that the MPC is leaning more towards more QE, the pound is likely to suffer and we would view GBP rallies as short opportunities.

Greek debt crisis remains in focus

The European debt crisis remains a major uncertainty for global financial markets with a Greek default becoming more a question of when and how orderly as opposed to if. The beginning of this week saw Greece 2-year yields above 76%, several peripheral yield spreads over Germany at their highest levels, and record high 5-year CDS for Spain, Italy, Portugal, Greece, France, and Belgium. As a result of continued commitment by EU officials to implement the July 21 agreements which eased worries of an imminent Greek default, financial stresses in the Euro zone have receded with Greek 2-yr yields testing 50% today as well as yield spreads and CDS tightening. Angela Merkel said that Germany has a duty to help secure the euro's future in an attempt to ease markets.

European Finance Ministers have gathered in Poland for the start of this weekend's EcoFin meeting to discuss the EFSF, Greece aid, and a collateral deal. The market remains skeptical on a tangible outcome which has put pressure on the common currency. EUR/USD was rejected from the 38.2% Fib retracement of the decline from the highs above 1.4550 to the near 1.35 lows and the pair is currently trading around the 1.38 figure. Also weighing on the euro is the shift in stance by the ECB. The bank has turned more dovish noting that the risks to growth are to the downside and inflationary risks are no longer to the upside. In the week ahead, Europe will see PMI's out of Germany, France and the Euro zone to give indication on the state of the economy in the region. The market is also keeping a close eye on Italy's Aa2 credit rating as Moody's placed Italy on watch negative three months ago today.

Key technical resistance in the EUR/USD can be found around the 1.4030 zone which is where the 50% Fibonacci retracement of the previously mentioned move comes in as well as where the 200-day simple moving average lies. Additionally, the 200-week SMA is currently around 1.4015 and the daily Kijun line as well as the weekly Tenkan line converge around the 1.4020/25 area to provided added resistance. The convergence of several key daily and weekly technical levels is likely to limit further upside in the EUR/USD pair.

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. FOREX.com is regulated by the Commodity Futures Trading Commission (CFTC) in the US, by the Financial Services Authority (FSA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan.

Eric Viloria, CMT | Senior Currency Strategist | FOREX.com

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The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase or sale of any currency or CFD contract. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. Any references to historical price movements or levels is informational based on our analysis and we do not represent or warranty that any such movements or levels are likely to reoccur in the future. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.

Foreign Exchange and other leveraged products involves significant risk of loss and is not suitable for all investors. Increasing leverage increases risk. Spot Gold and Silver contracts are not subject to regulation under the U.S. Commodity Exchange Act. Contracts for Difference (CFDs) are not available for US residents. Before deciding to trade forex, you should carefully consider your financial objectives, level of experience and risk appetite. Any opinions, news, research, analyses, prices or other information contained herein is intended as general information about the subject matter covered and is provided with the understanding that FOREX.com is not rendering investment, legal, or tax advice. You should consult with appropriate counsel or other advisors on all investment, legal, or tax matters. FOREX.com is regulated by the Commodity Futures Trading Commission (CFTC) in the US, by the Financial Services Authority (FSA) in the UK, the Australian Securities and Investment Commission (ASIC) in Australia, and the Financial Services Agency (FSA) in Japan.