Fed Minutes Fail to Rescue the Dollar

To the dismay of dollar bulls, the March FOMC minutes failed to rescue the dollar, causing the greenback to end the day lower against all of the major currencies. Apparently many policymakers are worried about low inflation and growth outside of the U.S. and the implications that it could have on the domestic economy. However a deeper look at the minutes revealed that there's still significant support for tightening. In fact, while "several on the FOMC argued against an April hike, some favored it." Some even felt that raising rates in March could be appropriate and they all agreed that the U.S. has been resilient amid global uncertainty. They saw further strengthening of the labor market, strength in housing and a moderate expansion in the economy despite global headwinds.

These are not comments reflective of a central bank that has given up on raising interest rates this year. Yet Fed fund futures are not pricing in a rate hike until June 2017. Not only does FOMC voter George believe that postponing a hike could undermine the Fed's goals but the latest comments from U.S. policymakers confirm that investors are underpricing tightening. FOMC voter Mester joined Rosengren in supporting gradual reduction of policy accommodation in 2016 and she even warned that waiting too long has risks. While Bullard who is also a voting member of the FOMC this year expressed some concern about low inflation he also touted the April jobs number as "another in string of good reports" and said he could back a rate hike if inflation expectations rise. The bottom line is that even policymakers who prefer to wait see reasons to raise interest rates this year and unless the U.S. economy hits some sudden road bumps their hawkishness will eventually be recognized by investors and when that happens the dollar will be due for a strong recovery.

Meanwhile the biggest story today is USD/JPY which dropped to a fresh 6 month low of 109.34. There was a brief intraday spike, but it was too shallow to be intervention. We have seen no signs of the Bank of Japan in the market, which is worrisome because it suggests that their pain threshold for yen strength could be much higher. In fact last night Japan's Tachibana said the economy could tolerate USD/JPY as long as it is trading above 100. Between the timing of his comment and his role in the communications team, the Japanese government could very well be waiting for a stronger move lower in USD/JPY before stepping in or they could be waiting for fiscal stimulus. Either way, this is a dangerous game that they are playing and one that will most certainly lead to greater strain on Japan's economy.

The greatest risk for the euro this week will be tomorrow's ECB minutes and the speech by Mario Draghi. The central bank unleashed a bold round of easing at their last monetary policy meeting and the minutes could outline all of the reasons why they felt that it was necessary. At the same time, euro has risen 6 cents since that meeting and Draghi may want to use tomorrow's speech as an opportunity to talk down the currency by reminding investors that they stand ready to add more stimulus if needed. For the time being EUR/USD is holding onto its gains thanks in part to the smaller decline in German industrial production but 1.1400 continues to be a level that the currency pair struggles to clear.

Unlike euro, sterling extended its losses against the greenback but the pressure on the dollar helped take the pair off its lows. No major U.K. economic reports were released today but when the pound starts moving in one direction, it needs to hit a critical level before reversing. That was exactly what we saw with GBP/USD today which bounced right off its 1.4000 support level.

The 5% rally in oil prices drove the Canadian dollar higher against the greenback despite significantly weaker than expected economic data. According to the IVEY PMI report, the manufacturing sector, which was expected to expand at a faster pace in March barely saw an increase in activity. The index dropped from 53.4 to 50.1, the second weakest level in 12 months. On a percentage basis, today's rise in oil prices is significant but on a dollar basis the $1.87 increase was nominal. Therefore even though inventories fell sharply, we believe USD/CAD remains a buy on dips but we prefer to come in closer to 1.3000.

The Australian and New Zealand dollars traded higher today on the back of the rise in stocks and stronger Chinese data. Service activity accelerated in the month of March, driving the PMI composite index back into expansionary territory. Between the manufacturing and service sector report, there are growing signs of stabilization in China's economy. Australia's construction PMI index is scheduled for release this evening but the greater market mover for AUD should be RBA assistant governor Kent's speech.