US Dollar May Rise as FOMC Minutes Bolster Interest Rate Outlook

The US Dollar may resume last week’s advance as minutes from June’s FOMC policy minutes inspire a supportive shift in the markets’ interest rate expectations.

Talking Points:

• US Dollar May Rise as FOMC Minutes Bolster Interest Rate Outlook

• British Pound May Not Find Strength in House Price Index Uptick

• Chinese CPI, PPI Figures Fail to Excite Currency Markets Overnight

The major currencies were little-changed in overnight trade as investors waited for the release of minutes from June’s FOMC meeting before committing to a directional bias. The US Dollar fell immediately after the policy announcement in an apparent response to officials’ downgrade of the 2014 US GDP outlook. Traders presumably took this to mean that the time gap between the end of QE asset purchases – expected in the fourth quarter of this year – and the onset of outright interest rate hikes will be relatively large.

As we discussed in the immediate aftermath of the FOMC announcement however, such an assessment seems off the mark. The policy statement itself struck a positive tone on the recovery’s progress while comments from Fed Chair Janet Yellen in the press conference following the sit-down struck a neutral tone. Meanwhile, a downgrade of officials’ 2014 GDP bets seems only natural given the economy’s dismal performance in the first quarter, which traders knew about and arguably priced in weeks before the FOMC result crossed the wires. Perhaps most critically, the central bank pressed on with “tapering” QE despite the lower growth forecast.

On balance, this suggests that there is room for investors to reconsider what the June announcement meant for Fed expectations, namely for timing of the first interest rate increase. With that in mind, signs of cautious optimism dismissive of the first-quarter slump as transitory may inspire a broad US Dollar advance against the benchmark currency’s leading counterparts. The greenback’s pairing with the Yen may be a lone exception if the prospect of sooner stimulus withdrawal triggers risk aversion, triggering an unwinding of carry trades funded in terms of the perennially low-yielding Japanese unit and sending it upward.

The Halifax measure of UK house prices headlines an otherwise bare economic calendar in European hours. The year-on-year growth rate is expected to hit 8.9 percent, the highest since October 2007. The BOE has argued it prefers to use macro-prudential tools rather than interest rate hikes to deal with the now worrisome effervescence of the UK property market, meaning the outcome is unlikely to spark policy tightening bets and thus offer little support to the British Pound. Furthermore, UK economic news-flow has increasingly underperformed relative to consensus forecasts since April, leaving the door open for a downside surprise just as GBP/USD technical positioning reveals hints of a downswing ahead.

June’s Chinese inflation figures failed to capture the markets’ attention overnight. The benchmark year-on-year CPI growth rate slowed to 2.3 percent, a hair lower than the 2.4 percent expected outcome. The results come against a backdrop of improving Chinese economic news-flow and a recent upgrade in 2014 Chinese GDP growth outlook (according to a Bloomberg survey of economists). On balance, that suggests today’s result offered little to disrupt investors’ priced-in world view, explaining the dismissive response from exchange rates.

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