10/09/2014 THE BIG PICTURE Falling, falling, falling Yet another down day for the dollar, with some quite serious drops – over 1% vs AUD and 1.8% vs NZD. Remember the days when we were complaining about a lack of volatility? In fact USD was firming until the FOMC minutes came out. They were unexpectedly dovish. Committee members noted a number of risks to the outlook, ranging from stalled growth in the Eurozone to trouble in the Middle East or Ukraine to the slow recovery in housing construction. Many members still believe that there is significant underutilization of labor resources, the key point that they will focus on in determining when to raise rates. The minutes suggest that the FOMC members are in no hurry to raise rates, which is in marked contrast to the rise in their estimates for the Fed funds rate (the “dot plot”). As a result, Fed funds rate expectations for 2017 collapsed a further 12 bps on top of Monday’s 8 bps and the dollar came crashing down with them. In fact, inflation expectations have come down notably even since the FOMC meeting! The five-year breakeven inflation rate has fallen by around 22 bps to 1.68%, while the 5yr/5yr inflation swap so beloved of Mr. Draghi has fallen by 9 bps. Notably for us, there was considerable comment about the dollar. Some participants worried that further appreciation of the dollar could “have adverse effects on the US external sector.” “A couple of participants” also pointed out that a stronger dollar might exert downward pressure on inflation, making it harder for the Fed to reach its inflation target. These worries about the strength of the dollar were in marked contrast to yesterday’s sanguine comments by US Treasury Secretary Jack Lew, who said that “the strong dollar is good for the United States.” The Treasury, not the Fed, has control over the dollar so the FOMC’s comments do not imply any intervention to get the dollar’s value down. They do have a bearing on US monetary policy, however. There is a measure of “reflexivity,” insofar as the FOMC is influenced by the dollar and the dollar is influenced by the FOMC. In short, the FOMC minutes changed the outlook for US rates. Unfortunately there is no press conference after the October FOMC meeting, so we will not get any clarification of this conundrum any time soon – just drips and drabs from individual FOMC members. That means we are probably in for a period of greater volatility. We could also see further profit-taking in USD as investors scale back their expectations for tightening. Nonetheless I still see the US economy outperforming other economies and the US moving to a tighter monetary policy before most of its other counterparts, which should support USD. Today’s indicators: During the European day, German trade balance is coming out and the forecast is for the surplus to decline a bit, adding to the recent weak data coming from the country. In the UK, the Bank of England Monetary Policy Committee meets to decide on its key policy rate. The Bank is highly unlikely to change policy and therefore the impact on the market should be minimal, as usual. The minutes of the meeting though should make interesting reading when they are released on 22nd of October, especially after the continued deterioration of the UK economy. In the US, initial jobless claims for the week ended Oct.4 are coming out. The highlight of the day will be ECB President Mario Draghi and Fed Reserve Board Vice Chairman Stanley Fischer’s conversation on the latest developments in Europe and in global central banking. We could get some clarification about the widening divergence between the monetary policy outlooks of the two Banks. Fischer could also shed some light on the FOMC’s thinking. He is a relatively dovish person – both Reuters and Deutsche Bank rate him 2 on a scale of 1 to 5. Thus his comments could add to the USD-negative tone of the market. Besides those two, we have four more speakers on Thursday’s agenda. Riksbank Governor Stefan Ingves and ECB Governing Council member Ewald Nowotny speak during European time. During the US session, we have Richmond Fed President Jeffrey Lacker and San Francisco Fed President John Williams.
Posted on: Thu, 09 Oct 2014 08:26:42 +0000
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