Sterling-Dollar: Eyes on Fed Minutes for Balance Sheet Shrinkage + Latest Technical Forecasts

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The next major event for the Pound to Dollar exchange rate (GBP/USD) will be the release of the US Federal Reserve's June meeting minutes, out this evening at 19.00 BST.

The minutes are a record of the meeting at which the members of the Federal Reserve Open Market Committee (FOMC) decided to increase interest rates by 0.25% to 1.25%.

The minutes will be scrutinized by analysts seeking further confirmation of the market’s bias towards expecting another rate hike in December 2017.

If the minutes reveal a FOMC keen to get on with the job of raising interest rates then the Dollar will probably rise in reaction.

The will be quite technical, so those keen on watching the forex market through the event best get aquainted with the idea that probably of more importance that interest rate moves will be the question of the shrinking of the Fed's balance sheet.

The Fed's balance sheet stands at around $4.47bn, having ballooned in size courtesy of the gargantuan amounts of money made available via the quantitative easing programme - the printing of money to buy bonds in order to keep borrowing low and ultimately stimulate economic activity.

Cutting the balance sheet will see bond yields rise and, as a basic rule of thumb, is seen as positive for the Dollar.

The plan is to start the process with US$10bn per month in balance sheet shrinkage.

"The only real remaining question is when, and there's a risk that we get the answer in today’s minutes," says James Smith, Economist for Developed Markets at ING Bank N.V in London. "The Fed has moved faster than many thought on releasing its plan, and there have been some suggestions that the process could commence as early as September."

However, ING think the Fed will look to get another rate hike under its belt in September before commencing the balance sheet unwind in December.

An agressive move on timing i.e starting before December could well see the Dollar pop.

Others aren't so sure.

"Just a quick reality check for all those expecting a risk parity meltdown or dramatically higher US rates as the Fed starts the balance sheet unwind: The reality has been almost the exact opposite after every major fed program change since 2008," says Brent Donnelly at HSBC in New York.

Rate reaction to Fed balance sheet tightening

Donnelly says if rates - and by extension the US Dollar - follow the pattern again this year, we will see US rates rise until September and then peak as the Fed announces balance sheet reduction.

Also keep an eye on the nuances in the tone of the minutes.

Smith says the amount of times the word "transitory" is used to describe recent economic weakness will be watched closely.

The last set of minutes saw the word used nine times; anything less this time around could be positive for the Dollar.

ING are looking for a more optimistic tone on both economic growth and inflation which would justify the view that further interest rate rises are needed.

Sterling-Dollar Reactions

The GBP/USD exchange rate is seen at 1.2924 at the time of writing, having been rejected at 1.30 last week.

Forex.com's Fawad Razaqzada he does not expect the GBP/USD exchange rate to change much even if the minutes do reveal the FOMC is chomping at the bit to raise rates further:

“Several Fed speakers after that meeting have conveyed mostly hawkish remarks, reiterating what had been said in the June rate decision. So if the Dollar is going to make a significant move it will be because of this week's upcoming data rather than today's release of FOMC minutes."

Razaqzada's stance is bullish for GBP/USD overall.  

“From a technical perspective, the GBP/USD still looks bullish to me despite this week’s Dollar rebound. As one would have expected after a large range expansion last week, the cable has stalled around that key resistance and psychological hurdle at 1.30 again,” says Razaqzada.

Whilst upside has hit an obstacle, the analyst notes how no significant support levels have been breached either, suggesting a lack of bearish conviction.

If the pair falls as low as 1.2815, in fact, the analyst would see this as a good buying opportunity, rather than a threat to the bull trend:

“If the cable drops to this level, I would expect to see a reaction and a possible resumption of the bullish trend. Alternatively, if the cable doesn’t hit this level and bounces then we would be waiting for an eventual break above 1.3000/3050 area. A clean break here could pave the way for a move towards the next bullish objectives at 1.3240 and then 1.3450.”

Only a break of last week’s low at 1.2705 would change the bullish bias.

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Going Lower

Lloyds Bank Commercial Banking’s Robin Wilkin’s concurs with Razaqzada’s slightly negative outlook for the Dollar.

“Our studies suggest a stronger USD correction can be seen in the short-term, so tonight’s release of the June FOMC minutes will be of interest. At the meeting, the committee raised policy rates and indicated that the process of shrinking the inflated balance sheet is likely to begin relatively soon. The minutes will be scrutinised on the likely timing of this process,” said Wilkins, hinting that the market could be disappointed at the minutes which may not make special reference to future policy.

Lloyds see GBP/USD as in a range now between 1.27 and 1.30.

“While under 1.30-1.31 resistance, we are biased for a move lower within the current range,” said Wilkins.

There is, “more meaningful pivot support in the 1.2850-1.2750 region.”

For an exit from the holding pattern, “A clear break of 1.31 is needed to open next resistance in the 1.3375-1.3500 region,” concluded Lloyds.

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FX Broker Hantec’s Analyst Richard Perry is more bullish for the Dollar and sees a chance of more upside for the currency if the Fed argues the recent fall in inflation is only “transitory”.

“An assertion that the recent inflation weakness is only transitory and will pick up again as the year progresses will increase expectation of a third 2017 hike in December. This would pull yields higher, strengthen the dollar and be likely to drag on equities.”

Like Lloyds’s Wilkins, Perry describes a range forming on GBP/USD between 1.26 and 1.30.

“This correction back from $1.3030 was under the $1.3047 key May high and suggests that a medium-term range is now in formation between $1.2600/$1.3050. With the recent rally falling over there is a potential now for another retracement back towards the pivot at $1.2775.”

Overall Perry sees downside muted and upside exalted.

“Momentum indicators are somewhat ranging now on a medium-term basis and are rolling over to give the daily chart a near term corrective outlook. However the selling pressure does not appear to be too excessive and for now this seems to be a fairly orderly correction. The hourly chart reflects this outlook and with a drop below $1.2945 there is a near term corrective target of $1.2860.”

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