Forex Investment and Currency Trading

Yesterday’s FOMC statement kept rates on hold and shifted toward greater inflation risk and less economic risks, but with both roughly balanced there was no hint of an imminent tightening and the dollar was sold aggressively to EUR 1.5670.  Early London traders sold Euro to the 55 day moving average around 1.5625 but continued softening of US yields sparked Euro buying to near 1.5740 resistance.  The 2 year USD swap spread has now dipped 30 bps from near 4% in mid-June, yesterday representing a key reversal day which suggests more USD downside.  The Dow’s negative open, now -200, reflects continued financial write-down fears, but Euro/dollar doesn’t want to try the next upside target of 1.5837 (consistent with USD index trendline support at 72.08) just yet.  Dollar/yen has remained over 107, albeit unable to close over the 200 day moving average around 108 for several days, suggesting downside.  But Euro/yen saw a new all-time high near 169.50, a hint that risk appetite is not collapsing.  EM are roughly stronger on the Fed announcement, as the likes of Brazil and Indonesia can afford to hike rates to counter inflation.  Today’s US data is mixed: initial unemployment claims unchanged but continuing claims elevated, reflecting jobs are hard to find; final 1Q GDP was revised up from .9% to 1.0% as higher domestic demand left inventories leaner and modestly improves 2Q prospects to near 2% annualized; and existing home sales rose .2% while prices declines decelerated.  This has helped stabilized the dollar for now. 
 
CNY Alert

• The recent move by China to increase domestic fuel prices represents a courageous measure to reduce a meaningful subsidy, diminish long-term inflation risks and possibly introduce greater flexibility into the economy.
• Nonetheless, the price hikes will likely raise inflation in the near term by another 0.5%-0.8%.
• PBOC is running out of policy options to suppress inflation with a further slip in USD/CNY likely providing an increasingly palatable and productive solution.
• USD/CNY will likely reach 6.75 by the end of 3Q or a slightly lower rate than consensus estimate and the present level of the 3 month NDF of 6.78. The pair will likely reach 6.65 by the end of 2008.