NEWS / Foreign Exchange

EUR/USD crosses the road

• Treasury curve bull steepens on Fed??™s aperture
• Euro zone calendar heats up
• EUR/USD crosses the road
• Bernanke Fed in the footsteps of the Greenspan Fed
  

EUR/USD was pretty much stable in the run-up to the Fed meeting. EUR/USD dipped just slightly from the 1.3320 zone to the 1.33 area, but such moves are too small to have a clear reason. Then the Fed came into the play. The FOMC decided to keep rates steady at 5.25% as expected, but the main attention was for the language in the statement anyway. There were some major surprises. We had expected a toning down on the economy, but that change was less clear as we expected as the long-term outlook was unchanged, despite admitting that ???recent indicators have been mixed??™. The Fed also showed still some concern for inflation, but to a lesser degree than we had thought, as it dropped the explicit tightening bias. This was the most important element to disappoint the dollar believers.

The reaction was quite logical on the forex markets. The dollar lost ground, with EUR/USD even briefly above 1.34, as everybody was surprised by the many alterations to the Fed statement and bias. This confirms that a period of steady rates is here, but it also in our view opens the road to a rate cut during the Summer if needed. That is why it was a dollar bearish statement. We feel this could set the tone for more dollar softness to come. The trade-weighted dollar stands at 82.75, a whisker away form the 2006 lows at 82.24. We also point out that the all time lows stand at 80.39, reached late 2004.

The fact that EUR/USD has moved above the 1.3367 mark, the 20006 high, also shows that the technical picture has now turned more negative for the dollar. This is a bad thing and makes us continue with a sell-USD-into-strength approach, as we look for more upside in this pair.

In USD/JPY, we first saw a rise in this pair ahead of the FOMC. Yen longs were halted, as equity market turmoil seems to be cooling down. This brought the pair up from the 117.30 zone to the 117.80 area. As the Fed disappointed dollar believers, this move was completely reversed, with the USD/JPY pair spiking back down to the 117.30 zone, so at the end of the day no much had happened in this pair.

We however stick to our deeper concerns for the USD. It is obvious that the Fed statement of yesterday evening does nothing to alter this, much to the contrary, the bias is clear. The USD is at risk of seeing rate cuts and this could erode confidence. Eventually, this could drive down the big rate differential between Japan and the US and make carry trades less interesting. More of a reversal of carry trade thinking would be seen as dollar negative, or shouldn??™t we rather say as yen positive in general, as in many yen crosses this game is being played.

These may be longer term views, while we have seen a sideways picture in USD/JPY for the moment. Still, we have to adhere to some buying yen on softness approach. That seems the fundamentally logical thing to do at this stage. However, the Japanese themselves seem very careful not to give the impression to be supporting the yen, as this morning BoJ??™s Fukui made some dovish comments. He said he didn??™t want to give the impression he had a tightening bias and he wanted to maintain easy monetary conditions. His words also seem inspired by some sense of underpinning the asset markets, as he also said the BoJ was watching asset markets??¦

EUR/GBP retreated sharply earlier this week, dipping form the 0.6860 zone to the 0.6780 area. Yesterday, this downfall was halted and to some degree reversed. This came about as the BOE Minutes disappointed and as the euro was sought as safe haven, on some spill-over effects form the sharp rise in EUR/USD and EUR/JPY. GBP/USD also rose, but slightly less, so the resultant was EUR/GBP moving to the 0.68 area. It is always difficult for EUR/GBP to ignore EUR/USD??™s direction; that has been proven on many occasions in the past.

Recent price action clearly demonstrated our belief in a sterling comeback. This was set back yesterday by the somewhat dovish Minutes outcome, showing 8 members on hold, including hawks Sentance and Besley, while the dove Blanchflower voted for a shock rate cut. As one can see the debate will be raging again hard at the Bank. These Minutes were done before the Bank received the higher than expected CPI numbers, so these can change things again, putting the hawks again on the offensive. The picture on rates is thus still clouded in the UK, but we feel the market should take into account rate hike chances somewhat more in the UK and this would be a supporting factor for the sterling going forward.