FOMC to Decide EUR/USD Breakout or Fakeout

With European bond yields continuing to decline and bond spreads throughout Europe compressing, the euro broke the top side of its 2.5 week range, rising to an intraday high of 1.3236 against the U.S. dollar. Despite weaker than expected U.S. durable goods, risk appetite is holding steady ahead of this afternoon's FOMC announcement. Sentiment in the markets is also healthier thanks to stronger earnings from Apple. Equity futures have increased, pointing to a higher open in stocks. ECB President Draghi spoke before the European Parliament earlier today on the economy and monetary policy. Although the head of the central bank said they never pre-commit to any policy action, his call for a "growth compact" versus a "fiscal compact" suggests that he has grown more concerned about the outlook for the region's economy. He also indicated that the uncertainty is "very very high" and that any discussion of an exit is "premature." Draghi's comments may have curtailed the breakout in the EUR/USD, but based on the price action, investors are clearly waiting for the FOMC announcement and Bernanke's press conference before deciding whether the euro should extend its gains or revert back to its range.

The big event risk today is the FOMC announcement but according to this morning's durable goods orders report, demand for big ticket items fell sharply in the month of March. Orders declined 4.2 percent, which was the largest drop in more than 3 years. Durable goods orders tend to be extremely volatile but with the FOMC meeting looming, this latest report will not please the Fed. There is a lot going on this afternoon so first and foremost, it is important to know exactly what time everything is expected. At 12:30pm ET, the central bank will release the FOMC Statement which be followed by their projections for the economy and the Fed Funds rate at 2:00pm ET. Then at 2:15pm ET Fed Chairman Ben Bernanke will hold a press conference clarifying the central bank’s decision. For forex traders, this translates into 3 distinct opportunities for volatility.

12:30pm ET / 16:30 GMT – Release of FOMC Statement

2:00pm ET / 18:00 GMT – FOMC to Release Quarterly Projections for the Economy and Fed Funds Rate

2:15pm ET / 18:15 GMT – Bernanke Holds Press Conference

FOMC Statement - The FOMC statement will most likely explain any intended changes in the central bank’s quarterly projections for the economy. It could touch on the recent deterioration in data but overall we don’t expect the tone of the statement to change much. There will be no hint of Quantitative Easing and no change in their plans to keep the level for the federal funds rate “exceptionally low” “at least through late 2014.” Fed President Lacker will probably go on record again for believing that economic conditions are unlikely to “warrant exceptionally low levels of the federal funds rate through late 2014.”

Quarterly Projections – What we will be looking for in the Quarterly Projections are the changes to their inflation and unemployment forecasts as well as individual Fed Funds rate forecast. If any FOMC participants nudge forward their projections for tightening, it could be interpreted as less dovish and positive for the U.S. dollar.

Bernanke Press Conference – Bernanke’s comments on the other hand will probably temper the optimism in the market. When most economic data surprised to the upside, he stood out from the crowd to caution about the sustainability of the gains in employment. Since then, not only have his concerns been validated by soft payroll growth and higher jobless claims, but we have also seen weakness in the housing and manufacturing sectors. In recent months, Bernanke has been far more dovish than some of his peers and it is unlikely that his views have changed since March.

We do not believe the outcome of tomorrow’s meeting will be as clear cut as some investors and economists hope and instead expect the Fed to create more confusion than clarity. There is no question that the recovery in the U.S economy is losing momentum but consumers are still spending and companies are still hiring. Unlike last month’s Fed meeting where there was only the FOMC statement to key off of, Quarterly Economic Projections are scheduled for release followed by a press conference with Bernanke. This schedule is supposed to give the Fed 3 opportunities to clarify their plans for monetary policy but instead it will be 3 opportunities to confuse investors this month. To see how this could happen, we only need to remember back to March when the disconnect between the more optimistic FOMC statement and more pessimistic comments from Bernanke days later created widespread volatility for the U.S dollar. What will probably create the most confusion are the Fed forecast levels. The central bank’s inflation forecasts will most likely need to be revised upwards given the increase in gas prices since January and their unemployment forecast will need be lowered because the jobless rate has already reached their January forecasts. If the Fed increases their inflation and lowers their unemployment projections, the case for QE3 weakens significantly. As a result, we don’t expect the Fed or Bernanke to make it crystal clear that QE3 is necessary – the door is open but no one is ready to walk through it. At the end of the day, Federal Reserve officials are still very divided on monetary policy and given the level of market expectations, there is scope for a squeeze higher in the U.S. dollar after the FOMC announcement.