The U.S. Federal Reserve and the European Central Bank (ECB) are faced with opposite policy problems that will exert a greater and greater influence over the forex market in the next several months.
I expect the different stances of these two central banks to push the euro/dollar out of its recent trading range on the downside.
First let's take the Fed. The big debate at the Fed's March meeting, according to the minutes released in mid-April, was whether to "taper off" quantitative easing (QE) or not. Then the statement from the April meeting shifted the debate to the left when it said "the committee [Federal Open Market Committee] is prepared to increase or reduce the pace of its purchases to maintain appropriate policy accommodation…" The question became not whether to taper off or not, but whether to loosen further or to taper off.
But as usual the FOMC's statement also said that it would continue with QE "until the outlook for the labor market has improved substantially." That adds another question for the Fed: how do you define "substantial?" The April nonfarm payrolls data showed jobs have been rising an average of 200,000 jobs a month over the last seven months, versus only 130,000 a month as recently as last September. Does this qualify as "substantial"? Jeffrey Lacker certainly thinks it does.
Lacker, president of the Federal Reserve Bank of Richmond, Virginia, said about the figures, "I don't think there is any question...that we've seen substantial improvement in the labor market outlook over the last 6 months." Note the use of the phrase "substantial improvement." And just in case you missed the point, he added, "I think you ought to evaluate the likelihood of us reducing the pace of asset purchases accordingly."