Despite a heavy dose of U.S. economic reports this morning, the lack surprises left the control of the market in the hands of dollar bulls. The greenback held onto its gains ahead of this afternoon's Federal Reserve monetary policy announcement on the expectation that the Fed will be more upbeat and announce plans to shut down additional emergency programs.
Yesterday we learned that producer prices increased significantly in November but the strong price pressures on the wholesale level failed to translate into strong price pressures on the consumer level. This was partially due to discounting by apparel and electronic retailers as well as the fact that gasoline prices gradually declined last month even though oil prices held steady. Producers are having a tough time passing higher costs to consumers because demand is weak. On a headline basis, CPI rose 0.4 percent but if we exclude food and energy prices, consumer prices were unchanged last month, leaving the annualized CPI rate at 1.8 percent and 1.7 percent ex food and energy. Meanwhile the current account deficit widened in the third quarter from -$98B to -$108B, reminding everyone that the twin deficits are here to stay. The one area of continued strength is housing. Despite a drop in builder confidence, housing starts increased 8.9 percent while building permits rose 6.0 percent to the highest level in 12 months.
Counting Down to FOMC
For more on the FOMC Rate decision, read our FOMC Preview
We expect the dollar to remain firm ahead of the FOMC announcement. Based upon the price action in the forex, equity and bond markets, traders across different asset classes are all positioning for a hawkish outcome from the Fed. The 3 things that investors will be looking for will be the tone of the FOMC statement, changes to the discount rate and any plans to end emergency programs. The sharp moderation in job losses and improvement in consumer spending will encourage the Federal Reserve to grow more comfortable with the outlook for the U.S. economy. However there are still plenty of reasons why the Fed may not want to appear overly hawkish and therefore quite a bit of uncertainty rests with tomorrow’s FOMC statement. We only expect the bare minimum from the Fed because they realize that at this critical juncture in the U.S. recovery, there are more consequences than benefits to being overly hawkish. Although we believe that the Fed will underwhelm, dollar bulls may not need much to be satisfied and therefore any subtle changes to the language of the FOMC statement could affect how the dollar trades. A more upbeat tone by the Fed would be positive for the dollar while skepticism about the sustainability of the improvements in the labor market or consumer spending could reverse the greenback’s recent gains. The tone of FOMC decision should determine how the dollar trades for the remainder of the year.
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