FX market implications - TDS

Analysts at TD Securities explained that despite the indication that a September hike appears likely, FX markets may be more interested in the acknowledgement that interest rates are approaching neutral.

Key Quotes:

"This is not an immediate tradable event, however, but rather a process."

"The implication here is obvious; the Fed's runway has become shorter in comparison to its other central bank peers and that could eventually eat at the "divergence" narrative that has been so robust through Q2/Q3 and helped to support the USD."

"This, we think, is particularly relevant for USDJPY, where recent yield curve flexibility (and prospective changes down the road in this regard for various reasons related to output gap, JGB functioning, etc.) will help to create a more balanced influence in rate differentials. This will allow more room for idiosyncratic JPY factors to become relevant in the spread (as opposed to be just driven by the TSY leg)."

"Outside of the Fed, markets will need to contend with policy inertia for at least the next couple of months as the ECB has is waiting for taper to end but Italy budget deliberations will likely prevent EURUSD from achieving escape velocity. This to us, suggests that EURUSD is broadly still a "range-trade.""

"Interestingly enough, USDCAD dropped after the release of the minutes, which we find interesting because if the Fed is beginning to acknowledge that monetary policy is nearing neutral/becoming less accommodative (hence implying less room to hike), then that could extend — at least from a market pricing point of view — to the BoC curve going forward. With that in mind, would view dips below 1.30 in USDCAD as difficult to sustain and hence, opportunities to be bought into."