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All eyes will be on the Federal Reserve  this Wednesday  as markets anticipate a more hawkish tilt in the central bank’s tone as the economic conditions for the US has improved.

Follow a live blog of Janet Yellen’s press conference.

The labor market has improved in the last two months with the addition of 282,000 and 217,000 jobs respectively; inflation data released yesterday gained the most in a year at 0.4% and GDP for the second quarter is expected to accelerate to 4.0% which leaves room for the Federal Reserve to upgrade its current economic assessment.   With this backdrop, Yellen & company is likely to remain on its trajectory to reduce its bond purchases by another $10 bn to $35 bn.   Markets will parse the Fed’s statement for any indication of an increase in longer term interest rates and its forecast for US growth, following the announcement last week by Secretary Lew that the federal government has lowered its economic projection from 2.9% to 2.5%.

The Canadian dollar traded in a narrow 14 point range overnight with markets having little reaction to the news released after markets close yesterday that the Canadian government has approved Enbridge’s Northern Gateway pipeline.   This approval will pave the way for a conduit that would move oil from Albert to the Pacific coast for shipment to Asia.   The sole fundamental domestic release was wholesale trade sales which doubled expectations at 1.2% vs. 0.6% in April.

Moving to Europe, news flow has been light with construction output for the euro zone rising 0.8% in April following a decline of 0.6% in March, providing a bounce for the euro.   Divergence in central bank policy between the European central bank which introduced negative interest rates and the Federal Reserve anticipated to raise interest rates has placed pressure on the euro which has traded comfortably in a 75 point six session range.   Developments in Iraq with militants gaining partial control of Iraq’s main oil refinery and the threat of rising oil prices should firm inflationary pressures and will relieve pressure on the ECB and in turn support the euro.

Despite the pound’s rally with the release of Bank of England minutes, the rally quickly lost steam as it faced resistance at the 1.7000 handle.   In its minutes, the committee affirmed the central bank’s benchmark interest rate at 0.5% and maintained its bond purchases at $375 billion pounds and hinted that a rate hike could be in the horizon before year-end should the economy maintain its current momentum. The minutes follow Governor Mark Carney’s Mansion House speech last week that a rate rise “could happen sooner than markets currently expect.” The path to its first rate hike since the 2009 financial crisis will not be seamless as inflation remains subdued, divisions will emerge within the committee as to the amount of slack in the economy.

The overnight session saw Asian bourses, with the exception of the Nikkei and Singapore turn negative as market participants stood on the sidelines awaiting the Federal Reserve’s assessment of the US economy.   The yen traded sideways as fundamental data issued no surprises and the Bank of Japan minutes deviated little from previous prints.   Japan’s trade deficit narrowed for the 23rd consecutive month to ¥909 billion, while exports fell 2.7% on weak US and Asia demand with motor vehicle exports declining 4.3%, its first drop in 15 months.   The issue of exports is further compounded by a weaker yen and the need for Japan to import energy stemming from the shutdown of nuclear power plants of the 2011 Fukushima disaster.

In China, home prices rose 5.6% in May, decelerating from the previous print of 6.7%.   As China’s property sector account for twenty percent of GDP, a cooling housing market could mean that China would miss its GDP target of 7.4%, for the first time in 15 years.   President Xi Jinping has said that China may need to adapt to a “new normal” as the Chinese government work towards reducing debt levels and generating long term growth that is sustainable.   In other news, according to China Business News, the People’s Bank of China will be introducing “Pledged Supplementary Lending” (PSL) which will be supported by collateral.   The objective of this supplementary tool is to allow the central bank to use the PSL to set medium-term interest rates.

Further reading:

Politics and forex: fears for Europe?

Martin Weale echoes Carney’s rate comments – GBP/USD recovers