Fed Clarifications On Tapering

Officials are still trying to clarify for the markets what exactly the Fed’s intentions are with regards to “tapering off.” NY Fed President William Dudley’s speech on the labor market for recent graduates turned into the event of the day as he emphasized the difference between “tapering off” and “stopping” and also the difference between “tapering asset purchases” and “raising interest rates,” which he made clear is not going to happen for a long time.

While he expressed confidence in the economy, he also reiterated that the Fed’s plans are based on reaching its economic targets, not a calendar, and if the economy does not behave as expected they could prolong QE. His comments were echoed by Atlanta Fed President Lockhart, who said markets may have misread Bernanke’s comments and that low rates “will remain in place for a considerable time after the end of asset purchases”.

As a result, Fed Funds expectations for 2015 fell by around 6 bps and 10-year bond yields were down around 2 bps. They’re now down 15 bps from their peak on Tuesday.

It’s notable that USD gained against most currencies despite what was apparently a less hawkish view on interest rates. This suggests to us that while the currency is gaining support from interest rate differentials and the difference in policy expectations, it is also gaining strength from the relative strength of the US economy. For example, while Dudley said he saw “persuasive evidence of improved underlying fundamentals for much of the private sector of the US economy,” yesterday’s revisions of the UK GDP data showed that UK disposable income plunged 1.7% qoq in Q1, the worst drop since 1987. The weakness in the Eurozone needs no discussion. Japanese data released overnight showed some recovery there (industrial production and retail sales up) but good Japanese data tends to go with a weaker yen.

There is a lot of data to be released today, including producer prices from France and Italy, French consumer spending, German and Italian consumer prices, Italian business confidence, the Chicago PMI, U of Michigan consumer confidence (final for June), and Canadian GDP for April. The market expects a slight rise in German inflation to 1.7%, near the ECB’s 2% target. That could prove EUR-positive as it lessens the pressure on the ECB to ease policy, if indeed the ECB is still aiming its policy at inflation rather than growth.

The Market

EUR/USD
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• The accurate economist estimates for initial jobless claims, personal spending and the PCE deflator did not trigger a major move on the pair, however the largest increase in pending home sales in 1 ½ years, which added to data that show a housing rebound, drove EUR/USD to 1.3000 round number support. A rebound to 1.3055 materialised thereafter following Lockhart’s dovish comments. A retracement thereafter found support at 1.3030 with the pair rebounding overnight, finding significant resistance at 1.3075.

• Strong, well-tested resistance comes at 1.3075 which sees the 38.2% retracement level of the July 2012 – February 2013 up move, the 50-day MA as well as the 200-day MA. Initial support comes at 1.3055 and thereafter at 1.3030 and 1.3005, with Fibonacci support at 1.2980. Resistance above 1.3075 is found at 1.3115 and 1.3160.

USD/JPY
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• USD/JPY experienced a technical breakout during the European morning, as the pair penetrated its tested downward sloping trendline that coincided with the 23.6% retracement level of the November 2012 – May 2013 rally, with a 35 pip spike testing that level during the minute the US released initial jobless claims, personal spending and the PCE deflator figures. The overreaction, however only lasted a few seconds with the pair rebounding, furthering its gains as Japanese equities gained following the release of better than expected May industrial production and retail trade, with the Nomura/JMMA manufacturing PMI for June showing the greatest expansion since February 2011. On the Japanese CPI front, although the national CPI showed lessening deflationary pressures (mostly due to higher energy prices), both the national CPI and the Tokyo CPI excluding the volatile food and energy prices showed greater deflation than expected.

• The breakout from 98.80 may initially test 99.15 resistance, which also sees the 50-day MA. Thereafter weak resistance is found at 99.35, with the next resistance level being significantly higher, just below the 100-mark, with 99.90 seeming likely. The 97.90 – 98.10 level is likely to act as a notable support should we see a breakdown from current 98.80 support.

GBP/USD
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• GBP/USD continued to trade between technical levels on the announcement of fundamentals. The revised Q1 GDP data for the UK showed a significant drop in real household disposable incomes, driving the pair to 1.5270 support. A break down from that level occurred on the release of US data, which hinted at a possible future divergence in monetary policies between the BoE and the Fed. A rebound thereafter failed to break resistance with the strong U.S. pending home sales testing very significant 1.5200 support that sees two notable overlapping Fibonacci levels. A rebound that occurred following Lockhart’s dovish speech has the pair testing 1.5270 resistance.

• Resistance above 1.5270 comes at 1.5315 and thereafter at 1.5345, with significant support at 1.5200 and thereafter much lower at 1.5125.

Gold

• Gold continued to do what it does best this quarter, crashing yet again following a break of technical support, losing 2.8% relative to yesterday morning. The U.S. data employment and price data released yesterday did not change the view that the Fed may start tapering off QE in September, with the pending home sales indicating a strengthening housing market.

• Support, shown on this 4-hour chart, came at the weak $1180 which was last tested in August 2010. A better tested level that happens to be the 61.8% retracement level of the post-Lehman rally for gold is found at $1165, with support thereafter at $1128. A rebound may find initial resistance at $1224, with a breakout likely testing $1244.

Oil

• WTI had a predominantly technical day, retracing from $96.05 resistance to $95.65 support as the dollar generally gained following the announcement of 9K fewer initial jobless claims relative to the previous week. Crude thereafter broke resistance as Lockhart made remarks about continuing with an accommodative monetary policy, with the next resistance level being significantly higher at the weak $96.95.

• Notable resistance is now seen at $97.75, with resistance thereafter at $98.10 and $98.50. Support below $96.95 may come at the weak $96.50 level, with better-tested levels found at $96.05 and $95.65.

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