Why the Dollar Erased its Gains After the Fed Minutes

• Why Fed Minutes Erased the Dollar's Gains
• AUD: What to Expect for AU Employment and Chinese Trade
• NZD Soars to New Highs on RBNZ Comments
• CAD Rallies on Stronger Housing Data
• EUR: Market Ignores Draghi's Attempt to Talk Down Euro
• Chart: GBP/USD Mirrors Move in UK-US Yield Spread
• Rebound in Equities Drives Recovery in Yen Crosses

Why the Dollar Erased its Gains After the Fed Minutes

At face value, the minutes from the last FOMC meeting should not have driven the dollar lower.  The Federal Reserve acknowledged the improvements in the labor market, indicated that the risks to jobs, growth and inflation were broadly balanced and discussed exit strategies. They said the economy should rebound in the second quarter and if their outlook holds, they will end Quantitative Easing in October with a final $15 billion reduction in asset purchases. The dollar should have reacted positively to the prospect of QE ending in the beginning of Q4 and it did spike higher initially but 15 minutes after the Fed minutes were released, the dollar reversed course and gave up its gains. The decline in the dollar was driven completely by the reversal in U.S. yields.  On an intraday basis, 10-year yields traded as high as 2.60% but ended the day at 2.55%. While the dollar dropped because of yields, the decline in yields was caused by the failure of the Fed to provide a clear signal on when rates would rise.  Of course this lack of clarity is not surprising because Fed Chair Yellen refused to elaborate on this topic at the June meeting. As a result, the Fed minutes failed to satisfy investors, sending the dollar and yields sharply lower.  Yet as we noted in yesterday's note, even after today's moves, we believe the losses will be limited because at the end of the day, nothing new was revealed in the minutes and the Fed is still crawling towards an eventual tightening of monetary policy. The weekly jobless claims report is scheduled for release tomorrow.  We also have speeches scheduled for Fed Presidents George and Fischer - of the two Fischer is the only voting member of the FOMC this year.  

AUD: What to Expect for AU Employment and Chinese Trade

Despite the rise in Treasury yields, all 3 of the commodity currencies extended their gains against the greenback and whether these gains can be sustained will hinge in large part on tonight's economic reports.  Tonight is a big night for AUD and NZD with the Australian employment report and Chinese trade balance scheduled for release.  Both pieces of data are expected to be strong but when it comes to AU employment, the AUD/USD's reaction to the report will be affected by the breakdown between full and part time work along with the change in the unemployment rate.  Based on the PMIs, we are looking for a rebound in job growth.  Meanwhile with regards to China's trade report, the most important number to watch is exports as a sharp increase could accelerate the gains in AUD and NZD.  The New Zealand dollar continued to power higher today, rising to its strongest level since August 2011. The latest moves were driven by comments from Reserve Bank of New Zealand Deputy Governor McDermott who expressed concerns about the level of inflation. He said the tradeoff between growth and inflation is unsustainable because the trend of immigration is leading to faster output growth.  What makes his comments interesting is that they are coming at a time when inflation is still very low. In the first quarter, year over year inflation was only 1.5% with CPI likely to have fallen further in Q2 given the slide in dairy prices.  Nonetheless McDermott's comments make it clear that the central bank is committed to raising interest rates again this year even though credit card spending slowed in the month of June.  The country's business PMI index is scheduled for release this evening along with house prices.  The main resistance level to watch in NZD/USD is the 2011 high of 0.8843. USD/CAD trended lower on the back of stronger housing starts.

EUR: Market Ignores Draghi's Attempt to Talk Down Euro

The euro traded higher against the U.S. dollar today despite European Central Bank President Mario Draghi's attempts to talk down the currency. With no Eurozone economic reports scheduled for release, the focus of the market was on the comments from European policymakers.  Draghi, Coeure, Praet, Noyer and Nouy all spoke and naturally Draghi's comments were the most important. He said threats to euro-area price stability are real and there is unanimous agreement within the central bank to take further action if need be.  He stressed that ECB policy will remain accommodative for an extended period of time, which should have been negative for the currency but knowing that it will be another 2 to 3 months before the central bank considers easing again (and only if it is necessary), EUR/USD traded primarily on the markets reaction to the FOMC minutes.  According to Praet the ECB's latest policies need time to show results, an idea that we have been pressing since the last central bank. Nouy didn't say anything interesting but Coeure downplayed the strength of the euro. No major economic reports will be released from the Eurozone tomorrow.

Chart: GBP/USD Mirrors Move in UK-US Yield Spread

Once again, the British pound bounced off 1.71 to end the North American trading session higher against the U.S. dollar.  Sterling had been weak throughout the European session and into the first half of the U.S. session but when Treasury yields fell sharply after the FOMC minutes, GBP/USD soared. For anyone trading sterling, it is extremely important to keep an eye on the gap between U.K. and U.S. yields.   For most of the day, the spread was favoring GBP/USD weakness but by the afternoon, it shifted completely to favor GBP/USD strength (see chart below).  The earlier weakness in sterling was driven by a larger than expected decline in house prices.  According to Halifax, house prices fell 0.6% in the month of June compared to a forecast of -0.3%.  The visible trade balance is scheduled for release tomorrow and given the sharp rise in the PMI manufacturing report the deficit is expected to narrow.  Tomorrow's Bank of England monetary policy announcement will most likely be a nonevent for sterling since the central banks provides no details on their decision when policy is unchanged.

Rebound in Equities Drives Recovery in Yen Crosses

Thanks to the rebound in U.S. equities, all of the Japanese Yen crosses traded higher today.  CAD/JPY and NZD/JPY were the best performers as commodity currencies continue to attract demand.  USD/JPY found support at 101.45, near the same levels that the currency pair stalled at numerous times this year.  The sell-off in USD/JPY earlier this week was driven by the decline in Treasury yields but there was a limit to how far yields would fall given last week's strong non-farm payrolls report.  There is very little reason to believe that USD/JPY will break out of its 101.00 to 102.80 trading range this week.  Last night's machine tool orders report from Japan provided further evidence of the country's recovery.  Orders jumped to 34.2% on an annualized basis in the month of June, up from 24.1% in May. Producer prices, the Tertiary Industry Index and Machine Orders are scheduled for release this evening. The rise in Treasury yields during the North American trading session should keep the Yen crosses bid in Asia.