USD likely to remain supported ahead of September Fed meeting

Rather than give in to the summer lull markets have had some important news coming up throughout the month of July. Substantial policy changes from major central banks have been witnessed as economists and politicians attempt to juggle austerity and fiscal discipline in the context of dwindling growth. A growth undermined by cautious consumers, worldwide, playing safe and cutting back on spending ahead of any possible “rainy days”.

The euro weaker post ECB

The euro weakened; somewhat spooked, on Friday the 13th when seen against the US Dollar, it marked fresh two year lows at 1.2162. The sense remains that overall, despite the outline of necessary steps forward; politicians’ tackling of the crisis in Europe still lacks a necessary sense of urgency.

EU officials tell us that the Euro-wide bank supervisor will not be in place before mid-2013 and until than we note that the ESM (European Stability Mechanism) would be unable to inject funds directly into those banks in need of capital.

Yet of course the single currency was also weighed by the ECB’s decision, earlier this month, to lower its benchmark interest rate to 0.75% from 1% and to slash the deposit facility to 0%. Move which in layman’s terms is equivalent to increasing the supply of euros; which in itself reduces support for the same currency. At the time of writing, since month start, the euro is down an average 2.71% when seen against the major currencies - it loses mostly against the Aussie, JPY and the USD.

USD still in line for bullish headwinds in the near term

To the contrary, for the current month, the US dollar enjoyed average gains of 0.66% (seen against the major currencies), the greenback gained considerably against the euro and the CHF. Most of the USD’s gains come on the back of its safe haven appeal especially at times when investor optimism subsides but also because currency moves reflect interest rate differentials (meaning the difference in interest rates offered for the currencies in question).

Let’s put this into practice; compare the EUR/USD and the GBP/USD for example. With European and British central banks easing or slashing benchmark rates earlier this month, it is understandable that interest rate differentials work in favour of support for the USD because the Fed has not as yet embarked or taken a clear stance in that direction.

Won’t the Fed embark onto more easing or (simply put) continue providing US Dollars cheaply? Possibly, considering the deteriorating recent data out of the US, but as mentioned in my earlier article “ Fed could be easing; and USD strengthens “ dated 28th June “ the next FOMC meeting is not scheduled until early August and Forex investors will likely take the opportunity of a safe shelter in the meantime.”

In addition analysts are speculating that indeed the 1st August FOMC meeting is still too early for the Fed to commit to a new round of easing, and if anything does come up it will more likely be in the September meeting, so that the Fed has more time to gauge the economic situation. This in our opinion should continue to provide support for the USD in the near term.

Even the FOMC minutes published mid last week in fact revealed that only a few members of the committee expressed the view that further policy stimulus would likely be necessary – so despite the weaker US data and the risks going forward, further stimulus does not seem to have been justified, yet.

In the meantime investor focus will have most likely shifted to Bernanke’s congressional testimony (throughout Tuesday and Wednesday of the current week) for any possible clues – but as already mentioned it is unlikely that he would have committed to a direction ahead of the upcoming FOMC meeting.

GBP buoyed into positive territory despite weaker inflation briefly weakens it

Since month start the British pound has seen average gains of 0.40% when seen against the rest of the major currencies. Most of the gains for the GBP come from against the euro and CHF, which offset and beat the losses made against the rest of the majors.

Last Tuesday, UK inflation for the month of June came out lower than expected – which briefly weakened the GBP when seen against the USD and the euro. The lower than expected inflation data leaves the BoE with more maneuvering space should it decide to leave monetary policy loose for an extended period of time – which as inferred above would be negative for the currency.

This article has been prepared by Rudolf Muscat, Senior Trader at RTFX Ltd.