Forex Market Update: FOMC Statement Largely As Expected - Inflation Wording Strengthened, But No Hurry To Tighten Indicated. USD Weakens Aharply.

Equity and bond markets are back to where they started before the meeting. NZD weaker on Current Account Data - GDP on tap tonight.

MAJOR HEADLINES - PREVIOUS SESSION

• US FOMC left rate unchanged at 2.00% as expected
• New Zealand Q1 Current Account Balance out at -2.16B vs. -1.7B expected
• Australia May Job Vacancies rose 3.4% vs. -2.7% in Apr.
• Germany May Import Price Index rose 7.9% YoY vs. 6.9% expected and 5.7% in Apr.

THEMES TO WATCH - UPCOMING SESSION

Key event risks today (all times GMT):

• France Jun. Consumer Confidence (0645)
• Sweden May PPI (0730)
• Germany Jun. CPI - Hesse (0800)
• Norway Jun. Unemployment Rate (0800)
• UK BOE's King, Gieve and others to testify (0845)
• US Fed's Kohn to speak at ECB conference (1000)
• US Q1 Final GDP numbers (1230)
• US Weekly Initial Jobless Claims (1230)
• US Fed's Bullard to speak at ECB conference (1300)
• US May Existing Home Sales (1400)
• US Fed Governors hold open meeting on Basel II (1530)
• New Zealand Q1 GDP and May Trade Balance (2245)
• Japan May Jobless Rate (2330)
• Japan May Household Spending (2330)
• Japan May CPI and Jun. Tokyo CPI (2330)
• Japan May Industrial Production (2350)
• Japan May Retail Trade (2350)
• Australia RBA's Assistant Governor Debelle to speak (0430)

Market Comments

The FOMC statement was largely in-line with expectations, if perhaps a bit to the dovish side. The overall impression of the statement is that the Fed is trying to avoid saying anything at all. Perhaps this is a nod to Greenspeak, which was always intended to leave the Fed chairman maximum flexibility in the future course of monetary policy. While the Fed did notch up the rhetoric on inflation: 'upside risks to inflation and inflation expectations have increased' and 'uncertainty about the inflation outlook remains high', the rhetoric on growth worries still expressed concern, if less than last time around: 'Although downside risks to growth remain, they appear to have diminished somewhat.' The oddball sentence of the statement was the opening line: 'Recent information indicates that overall economic activity continues to expand, partly reflecting firming in household spending.' Exactly which economy is the Fed analyzing? Are they talking about household spending on food and gasoline, perhaps? This was a very weak statement and is probably the inevitable outcome of a deeply divided Fed committee, where some members - especially the known hawk Fisher who again voted for a 25 bps increase in rates - are firmly in the hawkish camp, while others are still very concerned about the ongoing housing/credit situation and its continued effect on growth. In any case, the statement certainly does not serve as a 'set-up' for any imminent policy tightening and leaves the market wondering when and if inflation will finally force the Fed's hand farther down the road.

The FX market reacted far more strongly than other markets to the Fed's statement. The US 2-year note yields are now only about 1 bp lower than they were before the FOMC, and equities failed to hold an initial rally that was theoretically triggered by a more dovish than expected statement. This also means that the interest rate differentials at present don't really support a further rally in EURUSD, so our fundamentals model leave us again with no decisive signal in the wake of yesterday's action. Let's see if the USD can rally like it did the last 3 times around in reaction to the FOMC meeting, or if the sell-off is real this time around (the initial reaction at the regular January and April meetings also saw a USD sell-off that yielded to USD strength in the days that followed, while the March meeting saw immediate USD strength, then USD weakness the following day, followed by a 400-pip sell-off in EURUSD subsequently...). Technically, the bears certainly need a swoon back below 1.5600 to get any short-term toehold on potential further downside. Look at a USDCHF chart for an idea of how clueless the market is on which way to go here - six consecutive days of large directional changes - and the last 4 weeks in a row have also seen large directional changes in this churning market.

So now, looking across the market, it appears that we FX traders have become commodity traders, as commodity inflation and sustained high interest rates seem to be the only relevant input into the trade decisions many are making of late. Many out there are talking up the carry trade again and the Yen's historic weakness in the face of commodity inflation due to its effect on the Japanese terms of trade. Projections of EURJPY are now being placed at 175 as all-time highs have traded in that pair yesterday and today. Who knows, perhaps this will all come to pass - but it will all depend on commodity prices remaining in their ever-upward trajectory and on ignoring growing signs of economic weakness around the world. The commodity trend is increasingly beginning to look like bubble-nomics - where it's impossible and unwise to try to pick a top. We can only look for technical signs of such a top occurring or at least for a fading reaction function in currencies to continued inputs of this nature.

With the FOMC meeting out of the way, focus will naturally increase on the ECB's plans for the future and next week's ECB meeting. The ECB maintains its hawkish rhetoric of late as evidenced by yesterday's comments by Trichet and Weber. Still, while it is 100% obvious and priced in that the ECB will hike 25 bps next week, Trichet still wants some wriggle-room (no doubt all Central Bankers do in case oil suddenly falls 40 dollars a barrel) by underlining that he hasn't said anything about a series of increases and that the ECB never pre-commits.

Yesterday, Norges Bank raised rates 25 bps to bring the rate to 5.75%. The market was apparently about evenly divided in expectations, so NOK strengthened on the decision. EURNOK is now trading at key 7.9400/7.9200 area, which has been an important flatline area in the last month, and also contains the 55-day and 200-day moving averages.

The New Zealand Current Account Balance was very disappointing and has touched off a fresh round of NZD weakness, as AUDNZD trades new 7-year highs. The NZD is looking increasingly vulnerable, though we may need to turn back the carry trade rally before we see the full downside potential for the kiwi. 0.7550 is an interesting area for NZDUSD if the USD tries to make a stand despite the initial FOMC reaction.

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