What Did the Fed Say to Drive the Dollar Lower?

• What Did the Fed Say to Drive the Dollar Lower?
• GBP: BoE Could Still Raise Rates in 2014
• EUR/CHF: No Surprises Expected from SNB
• NZD Boosted by Record Current Account Surplus
• AUD: Consumer Confidence Rebounds
• CAD: Sharp Rise in Wholesale Sales
• JPY: More Signs of Economy's Resilience to VAT Tax Increase

 

What Did the Fed Say to Drive the Dollar Lower?

 

Based on the performance of currencies and Treasuries, investors were disappointed by the Federal Reserve's monetary policy announcement. The central bank tapered asset purchases by $10 billion, lowered their unemployment rate forecast and raised their inflation forecast but the changes were small especially when compared to the sharp cut to their 2014 GDP outlook.  Not only did the dollar sell off across the board but 10 year Treasury yields also dropped below 2.6%.  It wasn't so much what the Fed said that drove the dollar lower but rather what they didn't say.  Janet Yellen acknowledged the improvements in the economy, indicated that the central bank is discussing tools for normalizing monetary policy and said that there would be a considerable period of time between the end of QE to the first rate hike.  When pressed for a definition of "considerable time," she refused to provide any details, saying only that there is no formula for what considerable time means.  In other words, unlike other central banks that have recently expressed their desire to become more active, the Fed remains comfortable with their current course and has no desire to alter the market's expectations.  Their acknowledgement of the improvements in the economy and the prospect of steady monetary policy also drove U.S. stocks to a record high today. While we don't expect a significant sell-off in the dollar, the greenback should extend its losses against the currencies of central banks who are looking to tighten. We've compiled our Top 10 Takeaways from the June FOMC statement but the bottom line is that nothing has changed.  Yellen promised to provide details on normalization later this year and we'll have to wait until then for more clarity on U.S. monetary policy.

 

Top 10 Takeaways from June FOMC Statement

 

1.     Monthly bond purchases cut by $10B to $35B

2.     Forecast changes - lower unemployment rate, higher inflation and significantly weaker growth

a.    2014 Unemployment forecast cut to 6%-6.1% vs. 6.1%-6.3% in March

 

b.     2014 Inflation forecast raised to 1.5%-1.7% vs. 1.5%-1.6% in March

c.     2014 GDP growth cut to 2.1%-2.3% from 2.8%-3% in March

3.     Fed sees slightly higher Fed Funds rate in 2015 (1.2% vs. 1.125% in March)

4.     Majority expect first rate hike in 2015

5.     Nearly all of the changes in the FOMC statement was in the first paragraph description of economy

6.     No Dissents - All new members vote in line with majority

7.     Policy remains accommodative, Fed repeats low rates likely

8.     Fed notes rebound in economic activity and improvement in labor market

9.     Unemployment rate though lower, remains elevated

10.   Household spending appears to be rising more quickly, business investment resumed its advance

 

GBP: BoE Could Still Raise Rates in 2014

 

The British pound ended the day slightly lower against most of the major currencies after the Bank of England minutes failed to be as hawkish as investors had hoped. Right before the Bank of England minutes were released, the hope for hawkish comments drove the GBP/USD to 1.70. Unfortunately the currency pair spent only a minute there before falling aggressively once investors realized that the minutes provided no explanation or support for Governor Carney's hawkishness. If anything the tone was more balance with no one dissenting from the decision to keep policy steady. While the central bank was more optimistic about growth, they all felt that there needed to be less slack in the economy before rates would be increased. On the housing market, the BoE stuck with the previous notion that the responsibility of cooling the market should rest with the Financial Planning Committee. The only potentially hawkish comment was their surprise that the market is pricing in such a low chance of a rate rise this year.  Unfortunately this was not enough to satisfy sterling bulls that have been looking forward to a new sense of hawkishness within the central bank. However the BoE could still raise interest rates in 2014.  Monetary policy committee member Weale said this morning that the "BoE may need to raise rates faster than markets anticipate" because "gradual rate increases may mean starting earlier." He felt the slack in the labor market is overstated and even if the central bank raises rates, policy will still be stimulative. BoE nominee Kristin Forbes said waiting too long to unwind QE may present risks and therefore it makes sense to withdraw stimulus gradually.  While we believe that the BoE is serious about tightening and sterling could still take out 1.70 in the medium term, in the short term U.K. retail sales are scheduled for release tomorrow and if the data surprises to the downside, we could see a deeper slide in GBP/USD.

 

EUR/CHF: No Surprises Expected from SNB

 

With no major Eurozone economic reports released today, the market's response to the FOMC meeting dictated the moves in the EUR/USD. This has and will continue to be a quiet week for EUR/USD, which has found support above 1.35.  Higher lows point to the possibility of a further bounce towards 1.3650. In Europe the focus will be on the Swiss National Bank's quarterly monetary policy announcement. A small subset of investors believe the Swiss National Bank could cut interest rates after the European Central Bank's easing but we think the chance is extremely slim. The last time we heard from the SNB, they reiterated their pledge to defend the 1.20 EUR/CHF floor and lowered their inflation forecast for 2014 and 2015 by 0.2%. With inflation ticking upwards and the unemployment rate declining, as long as EUR/CHF holds comfortably above 1.20, the SNB won't do more than reiterate its unwavering stance to defend the currency because some Swiss interest rates are effectively negative.  Furthermore, a strong housing market and ample liquidity minimizes the need for additional policy action.  Nonetheless if the SNB chooses to surprise the market with a rate cut, we expect the Swiss Franc to trade sharply lower against all of the major currencies.

 

NZD Boosted by Record Current Account Surplus

 

The New Zealand, Australian and Canadian dollars traded higher against the greenback today. Not only did New Zealand's current account balance return to surplus in the first quarter but the country reported its largest quarterly surplus ever.  Considering that economists were looking for a balance of 1.4B, the final outcome of 1.407B was not much of a surprise.  Dairy prices rose sharply in Q1, leading to a rise in the terms of trade.  The outcome of today's report is positive for NZD/USD but with dairy prices and the terms of trade falling in Q2, there's a good chance that the current account balance peaked in the first quarter.  Nonetheless, the improvement in the current account, the RBNZ's hawkishness, rise in real rates and increase in dairy prices will support the New Zealand dollar.  First quarter GDP numbers are scheduled for release this evening, stronger than expected growth should drive NZD/USD above 0.87 and AUD/NZD towards 1.0700.  Meanwhile a rise in consumer confidence in Australia helped to stem the slide in AUD/USD.  The jump in wholesale sales in Canada failed to help the loonie but come Friday when retail sales are released, the rise in wholesale sales points to the possibility of a rebound in spending.

 

JPY: More Signs of Economy's Resilience to VAT Tax Increase

 

Japan reported a trade deficit of 909 billion yen in the month of May, which was significantly better than expected.  Economists expected the deficit to balloon to 1.2 trillion from 811 billion but the actual increase last month was far less disastrous.  Unfortunately both exports and imports weakened with more than half of the decline in exports caused by a drop in demand for transport equipment such as cars.  Imports fell for the first time in 19 months as crude oil shipments dropped 20%.  This latest economic report is another reason why the Bank of Japan has held monetary policy steady since last year.  The lack of major deterioration reflects the economy's overall resilience to the VAT tax hike.  Department store sales declined for the second month in a row in May but compared to April, the pace decelerated significantly as the drag from the April sales tax hike continued to ease according to the Japan Department Stores Association.  Apparently favorable weather conditions and discounting helped to prop up sales for many retailers after the sales tax hike.  The Ministry of Finance's weekly portfolio report is scheduled for release this evening along with the all industry, leading and coincident indices.