After consolidating for 4 to 5 trading days, we've finally seen some relatively strong moves in the FX market (at least for a holiday week). EUR/USD shot above 1.1940 to a 1 month high, GBP/USD hit 1.3450 and USD/JPY broke below 113. These breakouts were driven primarily by U.S. dollar weakness but the continued strength of U.S. stocks also helped to propel these currencies higher. 2017 has been marked by persistent dollar weakness and with year-end flows easing it will close out the year in the same way despite today's rise in U.S. yields. Part of the weakness can be attributed to U.S. data, which came in mostly weaker today. The trade deficit increased rather than narrowed in November, jobless claims did not improve although manufacturing activity in the Chicago region accelerated.
The euro and Swiss Franc were the best performers. The Swissie had a delayed reaction to yesterday's stronger UBS consumption indicator while the euro found support from the ECB economic bulletin that described the "euro area economic expansion to be solid and broad-based across countries and sectors." They also said "underlying inflation is expected to rise gradually over the medium term." While this positive outlook is encouraging for the euro, it does not bring forward the market's expectations for ECB tightening. Germany continues to grapple with its political troubles as the SPD demands Merkel to form another grand coalition government. This is not an outcome that she favors. With no fresh Brexit news, sterling shrugged off lower finance loans for housing to trade to 1.3450 for the first time in 2 weeks.
All 3 of the commodity currencies performed well with USD/CAD dropping below 1.26 for the first time since mid October. Having not seen a rally in 7 trading days, the currency pair hit a 2 month low. This follows similar moves in the Australian and New Zealand dollars, which hit the same milestone earlier this week. Although oil prices hung out below $60 a barrel for most of the day, the recent strength of crude helped keep the uptrend in the loonie intact. With that in mind, 1.2600 is an important near term support level for USD/CAD and a tempting place to take profits on short positions ahead of the long weekend holiday. The Australian and New Zealand dollars also hit 2 year highs as the momentum of high beta currencies continued.
How Will the FOMC Change in 2018?
On this quiet day, we take the opportunity to talk about the makeup of the Federal Reserve's Open Market Committee in 2018. Aside from the departure of Janet Yellen, there will be a number of additional changes that could have a significant impact on the desire for tightening next year. Traditionally, the FOMC consists of 12 members - the 7 members of the Board of Governors, the President of the NY Fed and 4 Reserve Bank presidents who serve on a 1-year rotating basis. When Janet Yellen steps down in February, the FOMC will consist of the following members:
Fed Chair - Jerome Powell
Board of Governors - Lael Brainard
Board of Governors - Randal Quarles
NY Fed - William Dudley
Cleveland Fed - Loretta Mester
San Francisco Fed - John Williams
Atlanta Fed - Raphael Bostic
Richmond Fed - ??
Out goes Charles Evans and Neel Kashkari, the only 2 members to vote against the December rate hike and in comes Mester who is a hawk and Williams and Bostic who are centrists. Williams previously suggested that rates could rise 3 times next year while Bostic is less committed to a specific scale, having said there could be 2,3 or 4 hikes. The Richmond Fed still needs to appoint a replacement for Jeffrey Lacker who resigned in April and the NY Fed will need to find a replacement for William Dudley who plans to retire mid 2018. Aside from these open seats, there are still 4 vacancies on the Board of Governors. This month, Trump nominated economist Marvin Goodfriend to one of the vacancies. He is a widely respected monetary economist and former policymaker at the Richmond Fed that favors stricter inflation targeting and negative interest rates over quantitative easing. A few names have been floated around for Vice Chair - none of whom have direct monetary policy-making experience. There's talk that the White House is considering Richard Clarida (managing director of PIMCO NY), Lawrence Lindsay (Bush economic advisor) and John Taylor (noted economist) for the post. That leaves one additional Board of Governors spot and the replacements for the NY and Richmond Fed Presidents.
Of the confirmed members, we know that Powell and Dudley's views are aligned with Yellen's. Brainard is a dove, Quarles voted with the majority at the latest meeting, Mester, Williams and Bostic who are a bit more hawkish than dovish. So unless doves are nominated for the remaining posts, the central bank will have a more hawkish tilt in 2018. The market is only pricing in 1 full rate hike next year with a 65% chance of a second quarter point move over the next 12 months. This shows that investors are underpricing the possibility of tightening especially as policymakers have been talking about anywhere between 2 to 4 quarter point hikes. If the U.S. economy continues to expand like many expect next year, we could see the market adjust its rate hike expectations, which should be positive for the greenback.
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