© Dmytro Synelnychenko, Adobe Stock
- Fed minutes paint picture of an FOMC divided over rate cuts.
- But domestic and international context changed since July 31.
- Friday's address from Powell a watershed moment for markets.
- Comes as White House holds Fed to ransom with tariff threat.
The Dollar advanced against most rivals Thursday after minutes from the latest Federal Reserve (Fed) interest rate meeting painted a picture of outright division on the Federal Open Market Committee, which is expected to support the Dollar ahead of a landmark speech from Chairman Jerome Powell on Friday.
Federal Reserve interest rate policy will be the single largest determinant of exchange rates the world over in the months ahead, with the only exception being Pound Sterling, which is transfixed with a political process that could yet result in a 'no deal' Brexit. So it came as no surprise to analysts that the Dollar was buoyant overnight.
"While clearly disappointing those hoping for a dovish tilt and translating into weaker cyclical currencies, its effect should be temporary as the price action next week will be largely determined by Chair Powell’s speech in Jackson Hole tomorrow," says Petr Krpata, a strategist at ING.
The Federal Reserve cut its interest rate 25 basis points to 2.25% on July 31 and the vote split published at the time showed that only two of the 17 voters on the committee were against such a move. However, minutes of the meeting released late Wednesday evening showed that "several" member were in favour of leaving rates unchanged, which suggests at least one policymaker opposed a rate cut but ultimately ended up voting for it.
Only "a couple" on the committee of rate setters favoured delivering the 50 basis point reduction to the Federal Funds rate that financial markets were hoping to see at the time, suggesting a stark disconnect between the FOMC and market's views on the economic outlook. July's cut was billed by the Fed as a "mid-cycle" adjustment rather than the beginning of a so-called easing cycle, although the international context has changed for the worse since then, even if the domestic economy is holding up well.
Above: Dollar Index shown at daily intervals and annotated for recent events.
Fears on the FOMC have always been that a nascent global downturn will eventually hurt the U.S. through reduced demand for products made in America, although the Fed is constrained in the extent it can act by the elevated level of U.S. inflation and its statutory mandate to use interest rate policy to keep price pressures contained. Wednesday's minutes came just days ahead of an eagerly-anticipated speech from Fed Chairman Jerome Powell.
"As the global environment has clearly deteriorated since the July FOMC meeting (US imposing more tariffs on China, weaker data abroad) market participants are hoping for a more pronounced dovish shift. Unless this is delivered, and given the ongoing trade war overhang, the cyclical G10 currencies and EM FX are set to struggle while USD is set to stay bid (benefiting from a not overly dovish Fed– vs market expectations – and solid US domestic data –relative to other major economies)," Krpata says.
Powell's address during the opening ceremony of the annual Jackson Hole Symposium, which is a conference for the world's central bankers to talk policy, provides him and the Fed to an opportunity to inform the market about their thinking on the latest developments in the U.S. and global economies as well as the trade war with China.
Yield curves have inverted and fears for the global economy risen ever since President Donald Trump said in early August that he intends to impose a 10% tariff on all of China's exports to the U.S. that are not yet covered by punitive levies. Some tariffs are scheduled to go into effect on September 01 and the rest on December 15, which will mean substantially all of China's trade with the U.S. is encumbered by one levy or another.
Above: Pound-to-Dollar rate at daily intervals alongside Euro-to-Dollar rate (orange line, left axis).
"One key reason why markets are not regarding these minutes as hawkish as they could be is that these minutes refer to a meeting more than three weeks ago and a lot has happened since then," says Lee Hardman, a currency analyst at MUFG. "The risk is that, given the extent of market expectations for easing over the next 12 months, Chair Powell could again come across as more hawkish and encourage a stronger dollar."
For its part the U.S. economy has held up well when compared to peers elsewhere. Retail sales rose by a substantial 0.7% in July when the market consensus had been for a stil-notable 0.3% increase. And sales already grew 0.3% in June when a pessimistic market had been looking for them to fall. Those figures suggest the U.S. consumer has not been deterred by either the trade war with China, or the four Federal Reserve rate hikes announced in 2018.
Furthermore, the economy grew at annualised pace of 2.1% in the second-quarter which, although down from the 3.1% pace of expansion seen at the beginning of the year, was still far ahead of the market consensus for an increase of only 1.8%. All those figures underline the disconnect between the market's view of the U.S. economy, and that of the Federal Reserve.
Changes in rates are normally only made in response to movements in inflation, which is sensitive to GDP growth, but impact currencies because capital flows tend to move in the direction of the most advantageous or improving returns. Those flows tend to move in the direction of the most advantageous or improving returns, with a threat of lower rates normally seeing investors driven out of and deterred away from a currency.
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