Why the FOMC Statement Should Make Dollar Bulls Worried

Don't be fooled by the U.S. dollar's muted reaction to the FOMC statement. Every change that the Federal Reserve made suggests that they are more worried about inflation and less inclined to raise interest rates in March. To start, the economy is no longer "expanding at a moderate pace" but instead, "growth slowed late last year." Weakness was also cited in inventory investment, market based measures of inflation compensation "declined further," and inflation is expected to "remain low in the near term, in part because of further declines in energy prices." Policymakers removed the line describing the risks to the economy and labor market as balanced from the FOMC statement and replaced it with a warning that they are "closely monitoring global economic and financial developments" to determine whether the risks are truly balanced. They are no longer "reasonably confident" that inflation will rise and meet their 2% target, which implies that they are finally waking up to the risks of falling oil prices.

Every single adjustment to the FOMC statement points to a less hawkish central bank that could leave rates unchanged in March if oil prices and global equities fail to recovery. There are still 7 weeks and 2 non-farm payroll reports until the March meeting and a lot can change from now until then but today's FOMC statement gives investors fewer reasons to be long dollars. Although USD/JPY was unfazed by FOMC, rallies should be sold as we are looking for a move back to 118. Fed fund futures are spot on with speculators not looking for the Federal Reserve to raise interest rates again until the second half of 2016.

The Reserve Bank of New Zealand also left interest rates unchanged at 2.5% and like the Fed they have grown more worried about inflation but their concerns sent NZD/USD sharply lower. While policymakers expect headline inflation to increase in 2016, they believe it will take longer to reach their target. As such further NZD depreciation would be appropriate and further easing may be needed over the coming year. The difference between the Fed and RBNZ is that the Fed is hinting they could delay further tightening while the RBNZ is signaling plans to ease further. This divergence should keep pressure on NZD/USD. Also, it is worth noting that right before the RBNZ decision, New Zealand's largest dairy company lowered its milk forecast, which could be a precursor to a lower payout to farmers.

While NZD fell, AUD rallied on the back of stronger than expected consumer prices. CPI rose 0.4% in the fourth quarter and this increase lifted the annualized pace of growth to 1.7% from 1.5%. However it is hard to see how inflation could have bottomed in light of the additional pressure on commodity prices in the first month of the year along with China's economic slowdown. The RBA may not be actively considering easing at this time but with inflation undershooting their target and China expected to slow further, they will maintain a dovish bias for the foreseeable future.

Meanwhile it was another volatile day of trade for the Canadian dollar, which seesawed along side oil. Crude prices ended the day higher, which was initially negative for USD/CAD but the currency pair jumped after the FOMC announcement. Today's recovery in oil was driven by reports that Russia's energy ministry could be coordinating with OPEC but we remain skeptical about everyone's willingness to cut production. EIA also reported an increase in demand for heating oil, which is bullish for the commodity but the demand is directly related to the snowstorms in the Northeast.

The second worst performing currency today was the British pound, which fell sharply versus the U.S. dollar. This morning's housing market numbers were softer than expected but the slowdown in price growth is not the main cause of today's weakness. Instead investors are worried that if the Fed delays tightening and ends up only raising interest rates by another 25bp this year, then the Bank of England could forgo raising rates at all in 2016. U.K. GDP numbers are scheduled for release tomorrow and with spending falling 2 out of the last 3 months of the year, the risk is to the downside. Slower GDP growth would drive GBP/USD to 1.4200.

The euro traded firmly on the back of stronger than expected consumer confidence and a less hawkish FOMC statement. Today's move even helped drive EUR/CHF to a fresh 1 year high but for the most part the 1.1050 to 1.0700 range in EUR/USD remains intact and while overstretched short positions prevent the currency pair from falling aggressively, the ECB's dovishness will also cap rallies.