- GBP/USD steady near 1.38 on FOMC’s curveball
- Indicating QE taper may not come until Q4 2021
- Could challenge market bets on 2022 rate hikes
- Minutes say “too early to draw firm conclusions”
- “Significant uncertainty about” interest rate path
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The Pound-to-Dollar exchange rate entered the penultimate session of the week appearing well supported after minutes of June’s Federal Reserve (Fed) meeting asked awkward questions of market assumptions about the bank’s timeline for ending its quantitative easing (QE) programme and lifting interest rates.
Sterling was trading slightly on the south side of 1.38 against the Dollar but stabilising on Thursday following the release of minutes from June’s meeting of the Fed's Federal Open Market Committee (FOMC), which implied that the market may have gotten ahead of itself when assuming there’s a meaningful probability that interest rates could begin rising in the U.S. as soon as the end of next year.
“With the taper now on the table it really is down to the data that will determine the path forward,” says James Knightley, chief international economist at ING. “Given this backdrop we think the pressure to taper asset purchases will build over the summer with the taper potentially announced as soon as September, although today’s minutes would likely favour December.”
Investors and traders have wagered with increasing confidence since last month’s policy announcement that the Fed would be likely to lift its main interest rate range from between 0% and 0.25% before the end of 2022, while consensus among analysts and economists has favoured this September as the likely time at which U.S. policymakers would announce an intention to begin winding down the bank’s quantitative easing programme.
But the minutes make clear the risk that such an announcement comes later than that, in either November or December, which would see the Fed continuing with its yield-crushing purchases of government and mortgage bonds until well into the first quarter of next year due to its earlier commitment to provide the market with plenty of advance notice before making any changes.
Above: Pound-to-Dollar rate shown at hourly intervals alongside U.S. Dollar Index.
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“Investors were relieved that the Fed’s initial debate on tapering asset purchases lacked a coherent strategy on when and how it would happen,” says Philip Wee, an FX strategist at DBS Group Research in Singapore. “Expect DXY [Dollar Index] to hold a 92-93 range into Fed Chair Jerome Powell’s semi-annual congressional testimonies next week.”
The rub for investors and traders wagering on a 2022 rate rise is that, with the popular notion being that the Fed would likely reduce its $120bn per month purchases in monthly increments of just $10-$15bn, the bank may lack the time to squeeze in a rate rise next year even if it wanted to. This is especially the case as the Fed has already indicated an intention to end the QE programme before lifting its benchmark interest rate.
“We think the voices pressing for patience will remain the most powerful, so the fall labor market data are key to how Fed policy will evolve later this year,” says Ian Shepherdson, chief economist at Pantheon Macroeconomics.
Meanwhile, the rub for those holding bullish views on the Dollar is that should the U.S. central bank opt to wait until November before announcing anything, then it would potentially only just be beginning its tapering process at the point when the European Central Bank (ECB) is also expected to be winding down its own equivalent Pandemic Emergency Purchase Programme.
“The release of the FOMC meeting minutes from the June meeting illustrate a decision making body that retained a less hawkish tone compared to that assumed by some commentators following the change to the dot plot and the public statements by some dissenting voices in the committee following the meeting,” says Daniel Richards, a MENA economist at Emirates NBD. “Some members did think that tapering would start earlier than previously signposted, but there was consensus that they would ‘provide notice well in advance.”
Seven of the 18 participants at the meeting in June had used their contribution to the dot-plot of policymakers’ individual forecasts to indicate that they’d be willing to vote for an interest rate rise late next year, which pulled the rug from under other currencies including Pound Sterling and ignited a rally in Dollar exchange rates.
Above: Pound-to-Dollar rate shown at daily intervals alongside U.S. Dollar Index.
“What is holding them back seems to be the labour market with “many participants” noting that the “economy was still far from achieving the Committee’s broad-based and inclusive maximum-employment goal,” says ING’s Knightley.
Financial markets have wagered that U.S. rates will rise in response to decade-high levels of inflation, which the Fed says are “transitory,” although the bank has stressed repeatedly that it wants to keep borrowing costs as they are until it can be sure that its 2% average inflation target will be “sustainably achieved” and that a “broad-based and inclusive” definition of ‘full employment’ has been met.
“A few participants mentioned that they expected the economic conditions set out in the Committee’s forward guidance for the federal funds rate to be met somewhat earlier than they had projected in March. Several participants emphasized, however, that uncertainty around the economic outlook was elevated and that it was too early to draw firm conclusions about the paths of the labor market and inflation,” the minutes read.
“In their view, this heightened uncertainty regarding the evolution of the economy also implied significant uncertainty about the appropriate path of the federal funds rate,” the record states, before adding that some committee members felt it would be important to emphasise that the Fed’s “reaction function or commitment to its monetary policy framework had not changed.”
The next update from the bank is July 28 although before then Chairman Jerome Powell will appear before the Senate Banking Committee in Washington next week while other members of the FOMC will also be out on the speaking circuit.