Apart from German growth, 0.9% more than expected, best since the reunification, France also exceeded expectations, and the weak economies of Spain and Romania also showed positive growth rates. The initial figures for Q2 were definitely great, no matter how you look at them. But EUR/USD is still trading at around 1.2860. It climbed to 1.2915 but went back down to the same levels as before the release. Let’s see why:

1. Austerity measures to slow growth: In Q2, many governments in Europe adopted severed budget cuts. The impact of these cuts is still to be seen, and it’s expected to damage growth. The Greek economy shows us how austerity measures slow the economy.
2. Europe enjoying weak Euro: The common currency fell from a peak of 1.5144 in December 2009 to 1.1876 in June 2010. The weak Euro, also in its crosses against other currencies, helped European exports, especially export-oriented Germany. A weaker Euro is in the interest of European governments. While intervention is unlikely, any rise in the currency will hurt the economies, and will be followed by a drop of the currency.
3. Gloomy market mood: The statement from the Federal Reserve, that was analyzed as a great concern from a double dip recession in the US, is worrying for Europe. The US is usually the economic locomotive of the world. A new recession in the US means trouble elsewhere. And when there’s trouble all over – the US dollar benefits. So does the yen.

In recent days, we’ve seen how risk aversion plays a big role in trading – bad US figures mean a stronger dollar. If genuinely excellent numbers from Europe fail to lift the Euro, it seems that the Euro was rising only to resume falling.

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The Fed decision on Tuesday evening was digested on Wednesday, and the results were devastating. Fear of a global slowdown, or even a global double-dip recession sent stock markets tumbling down and forex traders flocking into “safe haven” currencies. The yen reached a fresh 15 year high against the dollar, and the dollar in tun made the highest daily gain in a long time. This first big wave is over. What now?

EUR/USD, that collapsed by over 300 pips, found support around the 1.2880 minor support line and managed to climb above 1.29. Further gains are capped by 1.30, the round number, and by 1.3114 that served as a clear line of resistance and later as a line of support.

Further on the road, 1.3267 provides further resistance. It was a support line in April, turned into a resistance line and was only temporarily breached after the disappointing US Non-Farm Payrolls.

But the direction seems down.

Technicals: Looking at the charts, we can see that the steep uptrend that characterized the pair’s trading in the past two months has been violently broken. After steep gains, this breakdown signals a sharp fall. Indeed, a steep downtrend channel is beginning to form.

If 1.2880 is convincingly broken, the next important support line for the pair appears at 1.2720. This is a rather new line. It capped the Euro’s gains during the strong rise for a comparably longer time than other lines.

Below, 1.2670 is the next line of support, followed by 1.2520 and 1.2460 – another strong line that capped the pair. Beyond this horizon there are more lines, with 1.2150 being the most important one.

Fundamentals: The FOMC Statement was a groundbreaking event. For many investors and analysts, it gave an official stamp to the worries about the US plunging into a double dip recession and taking the whole world with it. It has the same magnitude as their decision 17 months beforehand, in March 2009, when massive dollar printing was announced. The latest decision didn’t announce fresh dollar printing, but ignited deep fear.

This fear changed the paradigm once again. In the past two months, we’ve seen  ”normal” market behavior – when the US dollar weakened on weak US data. This has changed with the Fed decision – weak US data is expected to create more fear, strengthening the US dollar. Risk aversion is back. Big time.

European fundamentals aren’t too good. The debt crisis isn’t really behind us. The stress tests skipped the big issue of sovereign debt and eventually weren’t taken seriously.

We’ll get an important look at European fundamentals on Friday – GDP will be released, first for Germany. The Euro-zone’s locomotive holds high hopes of strong growth in Q2 – 1.3%. Will it live up to these expectations?

For the rest of the Euro-zone, expectations stand on a nice growth rate of 0.7%. Such growth rates haven’t been seen in a long time. Also here, a disappointment can be destructive.

Later on Friday, we get US retail sales, CPI and finally the consumer sentiment indicator from the University of Michigan. All figures are expected to be modest. Any disappointment will push EUR/USD lower, as the risk aversive trend is very strong.

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In my post about scenarios for the Fed decision, the scenario about the dollar sliding down had the highest probability. Indeed, this scenario was realized, as the Fed announced fresh dollar printing – and the result is as expected. While the headline was as expected and the result as well, the details are interesting:

Update: The trend has reversed - the Federal Reserve’s move triggered deep fears of a global economic slowdown. The risk factor is back in the game. Big time. The “safe haven” dollar and yen are now on the move, EUR/USD, GBP/USD and other “risky” currencies are falling.

The Federal Reserve announced that it will stop shrinking its balance sheet, and send the matured MBS back to the markets. The surprise came from the target of this new program – government bonds. This Quantitative Easing move will lower yields affects the mortgage market and is meant to make borrowing conditions easier – especially in the weakening housing sector.

Bernanke didn’t announce that the balance sheet will be enlarged, yet shifting the money to government bonds is an escalation in its steps. This shows that Bernanke is determined to prevent the US economy from sliding into the feared “double dip” recession.

Buying government bonds lowers their yields, making stocks more attractive. Indeed, stock markets immediately bounced back up.

The FOMC Statement details about the deterioration of the economy, which is recovering in a “more modest” fashion, and how the economic indicators have dropped since the last meeting of the Committee.

EUR/USD Erases False Break

Talks about dollar printing were here for over a weak, and they already took their toll on the dollar. But the tension reversed the trend. As the hours ticked towards the event, it seemed that it would turn into a “Buy by the rumor, sell by the fact”. The greenback regained its losses.

EUR/USD, that already passed the 1.3267 resistance line, lost it almost a day before the decision. In the hours before the announcement, it lost the all-important 1.3114 line, which it broke elegantly beforehand and remained safely above.

But with the release – this was erased – EUR/USD jumped over 1.32 and after calming down, it’s still far from 1.3114. The pair trades at 1.3180 at the time of writing. This turned out into a false break.

Also other currencies had the same behavior – losing ground before the release and winning against the dollar afterwards.

As always with decision from the Federal Reserve, it often takes time for the markets to fully digest the sometimes obscure messages, so we might have more surprises later on.

But after the dust fully settles, it’ll be each currency to its own: The Pound is in the limelight on Wednesday, the Aussie on Thursday and the Euro will attract attention on Friday. It’s never boring in forex trading!

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On Tuesday, August 10th, at 18:15, Ben Bernanke and his team will release the FOMC statement. I’ve already written about how Bernanke can print dollars and weaken the greenback, but as the market already prices in such steps, the impact on the market depends on the details:

1. Massive Dollar Spilling: The statement consists of a deep concern for a double dip recession and declares a program to buy assets in hundreds of billions of dollars. This is the worst case scenario. Showing worries might send traders away from the dollar. Spilling hundreds of billions of dollars in a new Quantitative Easing program means similar impact as in March 2009 – the dollar lost 600 pips against the Euro.  Bernanke wouldn’t want to create panic. Probability: Low.
2. Renewal of asset buying: The statement shows concern about the slowdown and states that the current asset buying program that was stopped in March 2010 will be temporarily resumed at a moderate scale.  Taking careful measures and carefully wording the statements is what the Fed does best. This scenario is bad for the dollar, but as the market already expects this, the dollar will slide down moderately. Probability: High
3. Change of wording: The statement shows concern about the slowdown, and vows to act if necessary, without any measures taken. Changing the wording of the statement without taking any steps is something that Bernanke mentioned in a recent public appearance. The market is expecting real steps to be taken, especially after the Non-Farm Payrolls, and while option won’t come as a huge surprise, not spilling dollars will boost the dollar, and erase some of the Euro’s recent gains. Probability: Medium.
4. No change in the statement: This means that the only dovish part in the statement is the pledge to keep interest rates low for “an extended period of time”. This “wait and see” policy, that happened so many times in the past will be a big surprise now, and will turn the recent gains of EUR USD to a case of “Buy by the rumor, sell by the fact”. The dollar will significantly rise. Probability: Low.

The chance of an optimistic statement about the economy is highly unlikely, and needless to say, the chance of a rate hike is zero. Inflation is no threat – the Federal Funds Rate will stay at a maximum rate of 0.25%.

What do think will happen?

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We’ve seen a sharp risk rally today – EUR/USD, GBP/USD, AUD/USD, NZD/USD rallied, USD/CAD dropped, while the “safe haven” currencies – the Swissy and the yen, didn’t move much against the dollar. This collapse of dollar continues the trend that we’ve seen in recent weeks, yet the scale was stronger. Here’s why:

The Federal Reserve meets on August 10th for the rate decision. The recent economic data shows that the economy is slowing down – no double dip recession, at least not yet, but certainly a slowdown.

Paul Sheard, global chief economist at at the Japanese Bank Nomura, suggests that the central bank won’t wait for a double-dip recession to be confirmed, but will act in the form of renewing quantitative easing steps by buying assets once again.

The meaning of buying assets, or enlarging the Fed’s balance sheet is printing dollars. And the meaning of printing dollars is devaluing the dollar.

Reminder of March 2009

On March 18th 2009, the FOMC decided on buying assets in a total value of 1.25 trillion dollars. This announcement of this inconceivable sum sent EUR/USD to a 600 pip leap and began a long term move that lasted for about 9 months, peaking at 1.5144 in December 2009.

Stock markets bottomed out and after the crisis and began rising. The price of oil bottomed out and began rising as well.

The US dollar lost ground across the board. A small reminder in the shape of a knee jerk reaction was seen now.

Dollar collapses with the article

In an article published on CNBC at 7:17 GMT (3:17 Eastern Time), Sheard is quoted:

“We therefore think the committee will return to the explicit language of early 2009, in which it articulated a commitment to ‘keep the size of the Federal Reserve’s balance sheet at a high level,’” he added.

I’m mentioning the publication timing of the article due to the market reaction at that time. A few currencies began a move at this timing – USD/CAD fell below the support line of 1.0280, GBP/USD moved above Friday’s 1.5720 peak (highest in 5 months), and AUD/USD jumped to a three month high, 0.9118, before continuing higher. All the moves happened just after the article was released.

Euro, Stocks and oil celebrate

EUR/USD began moving only during the New York session, but it also made an impressive move, above the tough 1.3114 and reached out for 1.32. This accelerated the move in the US dollar index, that made a big plunge from 81.55 to 80.90 at the time of writing.

US stock market indices are also rising strongly and so is oil. Crude oil leaped above $80, reaching almost $82 – the highest level in three months. This boosts loonie bulls.

If the Federal Reserve indeed announces new quantitative easing programs / dollar printing, I don’t think the effect will be as strong and as sustainable as in March 2009, as it won’t be a huge surprise like last time. Nevertheless, the US dollar will significantly weaken on such a scenario.

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Like any other good, the value of a currency is determined by the forces of supply and demand. However, in currencies the supply of currencies is controlled by the central banks. They are the single most influential entity on a currencies value. So, it is obviously advantageous to any trader to be able to see through the eyes of a central bank.

The Federal Reserve controls the US dollar, giving it the most influence on the market. According to its mandate the Federal Reserve has two goals, to maintain price stability (i.e. low inflation) and to maintain sustainable output (i.e. low unemployment). However, their actions reveal that their primary goal is to prevent deflation of the dollar (a situation with a strengthening value of the dollar and increasingly high interest rates). Of course this is related to maintaining low inflation, but the difference is that high inflation is embraced, while any level of deflation is feared like the plague. Remember that deflation takes power away from a central bank, while inflation strengthens it.

This is why the Federal Reserve prefers the dollar to lose value (there is also the fact that a weakening currency is beneficial for borrowers, i.e. the government, but that’s a topic for another day).This includes the dollar’s value against other currencies. But this poses a problem, other central banks want to devalue their currency as well, and due to the nature of the foreign exchange market, a loss in value of a currency is necessarily a gain in value for another currency. This puts the central banks at odds with each other.

When the world is relatively calm and in a sort of equilibrium, the Federal Reserve has the upper hand. When they do the dollar slowly devalues (except of course for the yen, since everyone borrows yen). But, when things begin to look bad and the demand for currencies begins to have a larger impact reducing the effectiveness of controlling the supply of a currency. This is what the situation has been in the last two years.

So here we stand today, the dust slowly clearing from the mess, and the Fed once again beginning to gain a firm grasp on its dollar manipulation. But it does not have that control yet. The situation in Greece put a huge dent in the Fed’s progress, and potential new problems still stand in the way (Australian housing bubble anyone?). The timing on interest rate hikes is unclear, but one thing is certain, the Fed will not be raising them until there is little risk of the dollar gaining value as a result.
So, put yourself in the shoes of the Federal Reserve and ask yourself what you would do to debase the value of the currency you oversee.

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The impact of Friday’s Non-Farm Payrolls will still be felt. After many days of dollar weakness, the Non-Farm Payrolls showed a nice gain in jobs, after many months of losses. This was corrective for the dollar.

There are two important American releases at the same time – ISM Non-Manufacturing PMI is expected to follow the same figure for the manufacturing sector and rise from 53 to 54 points.

On the other hand, Pending Home Sales will probably continue dropping – last time’s big fall of 7.6% is expected to be followed with a mild drop of 0.6% this time.

The third event is a special meeting of the Federal Reserve to discuss the discount rate. Bernanke already stunned the markets with the raise of this special rate, less important than the Federal Funds Rate. It then happened after the close of the New York session, but still caused lots of action.

This time, it happens during the New York session, at 15:30 GMT, but when Europeans and others are still on vacation. He might raise this rate again, and boost the dollar. Raising this discount rate indicates a closer raise of the FFR.

Near the end of the day, New Zealand’s NZIER Business Confidence will be released. This quarterly indicator usually rocks the kiwi. In New Zealand it will already be Tuesday. If you’re trading NZD/USD – watch out…

That’s it for today. Happy forex trading!

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• Adam Kritzer analyzes the latest rate moves by the Federal Reserve from a distance. The raise of the discount rate had a different impact on each currency.
• Michael Greenberg reports that 5500 comments have been submitted against the proposed regulation of 1:10 leverage limit by the CFTC. He claims that this isn’t enough.
• Kathy Lien shares her favorite currency pair: GBP/AUD and talks about the direction: down. I hold the same sentiment for a long time.
• Larry Greenberg talks about the Euro – a monetary union between 16 countries, and calls it an “imbalanced marriage:.
• Casey Stubbs discusses the importance of setting achievable goals for trading.
• Fransesc Riverola reports that the UAE shows more and more interest in forex trading. Forex is global…

That’s it. Have a great weekend!

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Ben Bernanke shocked the financial markets near the end of last week with a hike of the interbank discount rate. While Federal Reserve officials downplayed this move and announced it after the New York close, it had a strong effect on forex trading. Some currencies took it harder than others.

The Greek crisis is on the sidelines, but it might return to the limelight, especially on a day with few events. It currently seems contained, and affects only EUR/USD, but it could impact other currencies as well.

Now for the events:

Australia’s New Motor Vehicle Sales are posted a nice rise last month, and are expected to continue this trend. For more on the Aussie, which is expecting more rate hikes, read the AUD/USD forecast.

In Canada, BOC Senior Deputy Governor Paul Jenkins will make a public appearance and might refer to the central bank’s rate policy. This might move the loonie, currently at the critical 1.04 line. Read more in the Canadian dollar forecast.

Japan closes the day with the Monetary Policy Meeting Minutes which follow an unexciting rate decision. There are many discussions regarding the carry trade, and the yen’ role in it.

That’s it for today. Major events start pouring in tomorrow. Happy forex trading!

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Apart from the scheduled releases, note that the World Economic Forum talks start today in Davos, Switzerland. Statements from there can move the markets as well.

Australian CPI provides a strong start to the day. It’s predicted to rise by 0.4%, less than 1% that was printed last quarter. After PPI disappointed with a drop, a weaker number sure is possible. Also note the Trimmed Mean CPI, or Core CPI, which is predicted to rise by 0.6%.

This release critical for the rate decision next week. For more on the Aussie, read the AUD/USD forecast.

Following the rate decision in Japan and the downgrade by S&P, the BOJ Monthly Report could give a dark picture of the Japanese economy, despite the easing of deflation. On the other side of the day, Japanese Retail Sales are predicted to rise this time – by 0.3%.

German Prelim CPI will be released from the various German states during the the day. After last month’s 0.8% rise, a drop in prices is predicted this time. For more on the Euro, read the EUR/USD forecast.

In Britain, the day after the weak growth report brings another important figure: CBI Realized Sales. It’s expected to drop from 13 to 11 points, after a few good months. Also in Britain, MPC member Andrew Sentance will be speaking today.

For more on the GBP/USD, read the British Pound forecast.

In the US, Treasury Secretary Geithner will make a public appearance and might shake the markets. American New Home Sales are expected to recover from the blow they got last time, as they dropped to 355K. The number is expected to rise to 372K. This might have a muted impact, as a bigger American event is due later.

The Federal Reserve is expected to leave the interest rate unchanged at a maximum rate of 0.25%. Ben Bernanke is also expected to leave the wording of the FOMC Statement unchanged, with a renewed pledge to leave the rates low “for an extended period of time”.

Last month, it took the markets 6 hours to digest the statement before moving. It sure was confusing.

Also in New Zealand, the central bank makes a rate decision. Alan Bollard’s RBNZ isn’t expected to lift the Official Bank Rate above 2.5%. Prospects for the future might be hinted at the RBNZ Rate Statement. NZD/USD is getting close to 0.70 – a critical line for it.

That’s it for today. Happy forex trading!

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