FX Week 16 June 2013

FX Week

Focus is on the Fed in the week ahead

Currency markets, and indeed most financial markets around the world, will be firmly focused on the US Federal Reserve’s FOMC meeting this week. As one of only a few meetings a year at which new economic forecasts are released and a press conference held, there will be more than just the usual focus on whether Quantitative Easing is maintained. Even if there is no change to the current USD85bn of asset purchases conducted by the Fed every month (which is our base case), the opportunity will exist to present a timeframe in which a ‘tapering’ of QE purchases might be expected.
The immediate run-up to the meeting has been characterized by pronounced volatility in financial markets, but also by a continued steady firming in US economic data. US retail sales in May rose by 0.6%, weekly jobless claims fell by 12,000 and house price data has also been firm. However, uncertainty still exists over the manufacturing sector which remains weak, and inflation which at 1.1% is a long way below the Fed’s 2.0% target. Jobs are being created, but not necessarily fast enough to weigh on the unemployment rate. In addition, the fiscal tightening currently underway due to the sequester is drawing more criticism, with the IMF denouncing US fiscal policy as ‘excessively rapid and ill-designed’ over the weekend, claiming that it will knock 1.75% off growth this year and will further weaken it in 2014.
For these reasons it seems unlikely that the Fed will announce any change in the amount of assets being purchased just yet. This should serve to calm some of the fears in financial markets, although it will be in the detail of the economic forecasts that the real reaction will be generated. Greater optimism about growth, the labour market and inflation will increase the likelihood that ‘tapering’ will begin later this year, which we expect to begin in Q4.
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