Did Fed Minutes Kill USD’s Rally? Don’t Count On It

By Kathy Lien, Managing Director of FX Strategy for BK Asset Management,

It was a difficult day for the U.S. dollar, which retreated from its highs on the back of the FOMC minutes. Investors were looking for the minutes to reinforce Janet Yellen’s hawkishness but instead, it highlighted the concerns of some members who believe that progress on inflation may have slowed. While the central bank raised interest rates by 25bp at the last meeting and Yellen shared their plans to unwind asset purchases, the minutes showed “Fed officials divided over when to start balance-sheet run-off.” Several officials backed making a balance-sheet announcement over the next few months but others worried that because financial conditions eased despite hikes, it may be better to defer. So there was something for bulls and bears in the FOMC Minutes and for this reason, the dollar failed to extend its gains. But while dollar bulls were unimpressed, the mixed Minutes did not kill the dollar’s rally. Investors will still be looking for a stronger labor-market report on Friday, especially with manufacturing jobs on the rise. Jobs will be on everyone’s mind Thursday with ADP, Challenger Job Cuts and Non-Manufacturing ISM on the calendar. If healthier labor-market conditions are reported, we could see USD/JPY hit 114 pre-NFP.

After 3 days of losses, euro finally stabilized against the U.S. dollar. Part of the currency’s resilience had to do with the greenback’s pullback but better-than-expected Eurozone data also limited EUR/USD’s slide. Over the past few days, we’ve seen upward revisions to German manufacturing- and service- sector activity, similar changes to the broader Eurozone PMI indices and a rebound in retail sales. These consistent improvements in the Eurozone economy should attract buyers below 1.13, especially as ECB members Nowotny and Mersch share Draghi’s optimism. Nowotny called on the central bank to normalize policy as soon as the economy allows while Mersch said they would review asset purchases under the Quantitative Easing program in the not-too-distant future. However not everyone in the central bank believes that its time to reduce policy accommodation. Aside from the ECB’s comment that the market misjudged Draghi’s comments, ECB member Coeure said Wednesday that the governing council has not discussed policy changes. Earlier this week, Praet said their mission has not been accomplished and as such, “patience and persistence” is warranted. We suspect that there is more division within the central bank and so traders should not automatically expect Thursday’s ECB account of the last monetary-policy meeting to help the euro. If we are right and EUR/USD sells off on the report, we’ll be looking to buy near 1.1250 because it won’t be long before the ECB starts to talk taper.

Sterling also ended the day unchanged against the greenback but a deeper correction is possible after all 3 of this week’s U.K. PMI reports surprised to the downside, putting Bank of England Governor Mark Carney’s hawkishness into question. On Wednesday we saw the UK PMI services index drop to 53.4 from 53.8. Prices charged saw a decline while prices paid increased, warning of a potential profit squeeze on U.K. businesses. With no major U.K. economic reports scheduled for release on Thursday and Friday’s industrial production / trade balance reports expected to be softer after the lower PMI, the risk is to the downside for the British pound. GBP/USD raced above 1.30 after Carney spoke last week but has since failed to hold above this key level. Now, lower highs and lower lows put the currency pair at risk of a steeper decline toward 1.28.

Finally, there was very little consistency in the performance of the commodity currencies. The Canadian dollar traded slightly lower, the New Zealand dollar edged higher while the Australian dollar ended the day unchanged. Despite a 3% drop in oil prices, the Canadian dollar recovered its earlier losses to end the day down marginally. At the start of the NY trading session, USD/CAD rose above 1.30 but settled within 20 pips of its lows. Which shows just how strong the demand is for the Canadian dollar although the loonie also benefitted from a larger-than-anticipated oil inventory draw. Canada’s trade balance is scheduled for release Thursday followed by the country’s labor-market and IVEY PMI reports on Friday. Investors are hoping for hawkishness and maybe even a rate hike next week so these upcoming reports will be critical in securing the loonie’s strength ahead of the monetary policy meeting. The Reserve Bank of Australia left interest rates unchanged this past week and instead of rising, the currency fell on the back of renewed concerns for a strong currency. NZD rebounded off its lows as the U.S. dollar retreated, but with dairy prices falling for the second auction in a row and Chinese activity slowing, we expect renewed losses in AUD and NZD.