FOMC minutes key in the week ahead – RBS

Research Team at RBS, notes that the greenback continues to be held back by low expectations of Federal Reserve tightening this year.

Key Quotes

“But at current levels, America’s currency appears supported despite weak US data releases and cautious Fed speakers. Further, its stronger performance against sterling shows dollar divergence is likely to emerge again this year as the Fed resumes its rate hikes while other central banks ease monetary policy further.

Similarly, Fed officials last week appeared to give little support to the dollar. St Louis Fed President Bullard a voting Federal Open Market Committee member this year stuck to his new view that only one rate rise was likely from the Fed in the next few years as the economy’s ‘cyclical dynamics’ were basically over in his view.

The lack of clear signals from the Fed on the timing of future tightening plus lower volatility over the summer currently is supporting higher yielding currencies like the NZ dollar, South African rand and Turkish lira. But such trades are at risk as financial markets begin to focus on the prospects of the Fed resuming rate rises at its next meeting in September.

First, the US economy continues to meet the FOMC’s median forecasts of 2.0% growth, 4.7% unemployment and 1.7% core Personal Consumption Expenditure price inflation by the end of 2016. The Atlanta Fed’s current GDP tracker stands at 3.5%. July’s jobless rate was 4.9% and June’s core PCE inflation rate was 1.6%.

Second, the upcoming FOMC minutes in the week ahead are likely to underscore that near term risks to the outlook are receding as July’s meeting statement did but may also begin to tilt the Fed’s assessment of the balance of risks towards further tightening again. This would be a clear signal policymakers think September’s FOMC meeting could potentially be a ‘live’ venue for changing interest rates.

Third, policymakers expect labour market tightening will push up wages and return inflation to the Fed’s 2% target. June and July’s payrolls reports were both strong. Another firm report for August will increase FOMC members’ confidence further ahead of next month’s meeting.

Fourth, financial market conditions appear benign. The Fed’s broad, real trade-weighted dollar index edged above 98.0 in July but remains below its decade high of 101.2 recorded in December. The S&P has been making new all-time highs at 2,185. Ten year US yields at 1.50% are well below this year’s highs and China’s currency policy has been more stable compared to the start of the year.

We thus prefer to be a buyer rather than seller of dollars, particularly with the Bank of Japan also meeting on September 21.”