Financial Reader Digest

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Yesterday night (21st September 2010) FOMC news did a high impact on the US dollars! In fact, all the major shoot out against the US dollars which signify the weakness of this currency.

USD: RECESSION ENDED IN JUNE 2009?!

The U.S. dollar traded lower against all of the major currencies with the exception of the British pound ahead of Tuesday’s FOMC announcement. A number of economists expect the U.S. central bank to gear up for additional Quantitative Easing which is why the dollar has been sold pre-FOMC. Currency trends are usually determined by the direction of interest rates or monetary policy and the prospect of further stimulus has put the dollar under pressure. The only reason why sterling underperformed the dollar is because economic data from the U.K. suggests that the U.K. economy has taken a turn for the worse.

The U.S. economy on the other hand is not doing much better despite the National Bureau of Economic Research’s announcement that the recession officially ended in June 2009. Ask anyone on the streets of America and they will be shocked because for the past year, the U.S. economy has and continues to feel like it remains in recession. Does it really matter when the U.S. economy came out of recession when 14.9 million Americans are still unemployed and 43.6 million Americans are living in poverty? According to the National Association of Home Builders / Wells Fargo index, builder confidence held steady at an 18 month low. The expiration of the tax credit has put the housing market at a standstill. Aside from the Fed announcement, a number of housing market reports is also scheduled for release this week. We expect the data to show a similar lack of improvement as the NAHB survey. Before the 2:15pm NY time announcement tomorrow, housing starts and building permits will be released and an extremely modest increase is expected. The housing numbers should only be a minor distraction from the main event of the week, which is the FOMC announcement. This morning we published a thorough preview of the event risk including key language changes to watch for .

How Could Changes to the FOMC Statement Impact the U.S. dollar?

The Fed’s choice of words could have a significant impact on the U.S. dollar. The key words to look for in the FOMC statement are balance sheet and expansion. The balance sheet remained unchanged with the reinvestment of principal payments last month but if the Fed were to engage in large scale asset purchases (to the tone of $550B - $1T), it would increase the balance sheet and officially mark the beginning of QEII. With 3 monetary policy meetings before the end of the year, the odds that the Fed will authorize asset purchases tomorrow is extremely low but if they plan to do so in November, they will need to start telegraphing their intentions now to avoid greater volatility later. The dollar should sell off aggressively if the Fed says they stand ready to expand or increase the size of their balance sheet but if very little changes in tomorrow’s FOMC statement, it would suggest that the speculation about QE has gotten ahead of itself, which would be positive for the U.S. dollar. Alternatively, a middle ground could be for the Fed to announce a small amount of asset purchases ($200B - $300B) on Tuesday that is accompanied with some noncommittal comments about the possibility of additional purchases should the economy deteriorate further which would be bearish for the dollar. In addition, if the Fed plays around with the “extended period” language in the FOMC statement, it could also hurt the dollar. However there are not many adjustments the Fed could make that would sound more dovish than saying that economic and inflation conditions warrant “ exceptionally low levels of the federal funds rate for an extended period.” In terms of the economic outlook, the Fed is likely to acknowledge the improvements but warn that the risk is still heavily skewed to the downside.