Dollar Rebounds into Close after Fed Paints Gloomy Picture

It looks as if U.S. Dollar bears have a decisionto make after the Fed Minutes painted a gloomy picture of the economy.

It looks as if U.S. Dollar bears have a decision to makeafter the Fed Minutes painted a gloomy picture of the economy. Either theDollar will decline because of the Fed’s outlook or the Dollar will rallybecause of renewed risk aversion.

For the past few weeks, worse-than-expected U.S. economicreports have driven investors out of the Dollar and into foreign currencies butthis trend may becoming to an end as traders assess the Fed’s new outlook forthe economy.

Late Wednesday the Dollar began a small comeback followingthe release of the June Federal Open Market Committee Minutes. In the report,Fed officials issued an updated economic forecast calling for a downwardrevision of the Gross Domestic Product. In April, the Fed pegged the GDP growthrate at 3.2 percent to 3.7 percent. Today’s report showed a downward revisionof GDP to 3 percent to 3.5 percent.

The Fed also revised its forecast for the unemployment rate.The rate, now at 9.5 percent, is projected to drop to 9.2 percent in the bestcase scenario. In April, the Fed was calling for a decline to 9.1 percent.

Both downward projections paint a gloomy outlook for theeconomy, reflecting worries about how the European debt crisis could affect U.S. growth andjob prospects. Traders have to remember that Europeis in the midst of invoking financial austerity measures which are designed tocurtail spending. This could have a direct affect on demand for U.S. goods andservices leading to a drop in GDP and lower employment.

Although the Fed is projecting a decline in GDP andemployment, the Fed also saw less of a threat of inflation. The Fed predictedthat inflation would rise 1 to 1.1 percent, down from the April forecast of 1.2to 1.5 percent. This change in inflation reflects an expected drop in consumerspending.

Since the Fed is projecting low inflation, investors feel itnow has room to leave interest rates at historically low levels for a prolongedperiod of time.

The key factors contributing to the decline in the economyare household and business uncertainty, weak real estate markets, a weak jobmarket, diminishing fiscal stimulus and tight lending by banks.

Unlike April’s projections, this time “most” Fed officialsfelt that it would take “no more than five or six years” for the economy toreach its goals for maximum employment with low inflation. Previously, only aminority of Fed honchos thought it would take more than that time for theeconomy to recover.

U.S. Treasury markets rallied sharply higher following therelease of the Fed minutes, indicating fixed income investors are looking foryields to fall further. This move could be indicative of the start of anotherflight rally into the Dollar.

With the Euro currently toying with a major 50% level at1.2783, this spot on the chart would be the perfect spot for the start of acorrection. Furthermore, with less than ten days until the release of theEuropean bank stress test results and rumors afloat that eleven or more banksmay have failed the test, now would be the right time for the Euro to begin toweaken.

Today’s Fed report may have taken the spotlight away fromearnings season for the time being. A clash between those who want to sell theDollar because of better than expected earnings and those who want to buy theDollar because of renewed risk aversion may be on the horizon. This conflictbetween the two forces could trigger volatile conditions over the near-termwith sudden shifts in direction. It’s hard to predict at this time which waythe trend will develop, but what is clear is that traders are in for a rockytime in the markets over the short-run until one of the forces takes control.