Dollar Rebounds Awaiting Fed Minutes

Rising inflation could urge central bank to tighten faster

The USD rebounded against on Tuesday with North American markets coming out of a long weekend. The correlation between rising US bond yields and currency strength had broken down this year, but it now back on track with the 10 year Treasury note hitting a 10 year high driven by higher inflation expectations. The Fed has been divided internally on how to proceed in a slow inflation environment, but if prices suddenly accelerate there will not be need for debate with a higher pace of interest rate moves expected from the central bank. The January Federal Open Market Committee (FOMC) meeting was seen as hawkish and marked the end of Janet Yellen’s tenure. The notes from that meeting will be published on Tuesday, February 21 at 2:00 pm EST with the market scanning the documents looking for clues on the central bank’s views on inflation.

• CME FedWatch puts US interest rates 25 bps higher in March
• French, German and European flash PMIs expected to show slowdown
• FOMC minutes to provide clues on Fed’s inflation outlook

Market looking for clues on March rate decision

 

The EUR/USD lost 0.57 percent on Tuesday. The single currency is trading at 1.2336 with the USD regaining some traction after the Presidents’ Day holiday. The US dollar hit a three year low last week and it triggered some profit taking from dollar bears ahead of the release of the Fed’s minutes from the January FOMC meeting. The meeting went as expected on January 31 with the rate untouched at its 1.25 to 1.50 percent range. The statement provided few clues but the market zeroed in on the Fed anticipating inflation to reach the 2 percent target in the medium term.

The members of the FOMC have been divided between those that would rather hike now and let inflation catch up, to those more dovish who want higher inflation before raising interest rates. The final meeting chaired by Janet Yellen was hawkish by removing all the transitory factors and with a higher inflation outlook. The market is pricing in a 83.1 percent probability of a rate hike on March 21 as seen in the CME FedWatch tool.

The US central bank has forecasted 3 to 4 interest rate lifts this year. Several members of the FOMC have backed this view in their personal statements and with multiple signs of higher inflation the market, but the question remains. Why is the USD so low? The Fed hiked three times in 2017 and the market has once again priced in a Fed enacting a tighter monetary policy. Growth in the US is also expected to keep gaining at the same rate, but issues with political stability and rising twin deficits have made investors flock to other safe havens instead of the American currency.

European manufacturing data will kick off the Wednesday economic calendar. Flash PMIs for the EU, France and Germany will be published starting at 3:00 am EST with forecasted slowdowns across the board. If manufacturing in Europe is facing a slowdown it could add further momentum to a rising dollar if the minutes from the Fed meeting follow through on the hawkish Fed statement from January 31.

Market events to watch this week:

Wednesday, February 21

• 4:30am GBP Average Earnings Index 3m/y
• 2:00pm USD FOMC Meeting Minutes

Thursday, February 22

• 4:30am GBP Second Estimate GDP q/q
• 8:30am CAD Core Retail Sales m/m
• 11:00am USD Crude Oil Inventories
• 4:45pm NZD Retail Sales q/q

Friday, February 23

• 8:30am CAD CPI m/m

*All times EDT