FOMC Minutes Highlight FX Policy Divergences

The June FOMC minutes confirms that the Federal Reserve is edging closer to tapering asset purchases. According to today’s release, “various participants mentioned that they expected the conditions for beginning to reduce the pace of asset purchases to be met somewhat earlier than they had anticipated at previous meetings.” The U.S. dollar edged slightly higher on the back of the release as the Fed minutes support renewed greenback demand. U.S. policymakers are growing more comfortable with the idea of reducing asset purchases and an announcement could be made as quickly as the fourth quarter of 2021.

There’s little question that the Fed will taper before the European Central Bank. Eurozone data was disappointing with German industrial production falling for the second month in a row. Yet the dollar’s reaction was muted by the central bank’s view that the “substantial further progress” they wanted to see has not been met. Given the recent disappointments in service sector activity and wage growth, they will need to wait longer before making their moves. With that said, the comeback in the U.S. economy is accelerating with Americans ramping up spending on travel and other leisure activities.  Data should improve, building the case for Fed taper and renewed dollar gains.

Divergences in monetary policy will become a more important driver of currency flows in the coming months. The New Zealand dollar outperformed all other major currencies after more banks project a year end rate hike by the Reserve Bank. They won’t be the only ones tightening as Norway’s central bank signaled a rate hike in September. The European Central Bank, Bank of Japan and Swiss National Bank will trail far behind, creating fresh opportunities in pairs such as EUR/NZD and NZDJPY.

Germany’s trade report is due for release tomorrow but all eyes will be on Canada. The IVEY PMI index rose from 64.7 to 71.9, its strongest level in 3 months. Labor market numbers are due for release on Friday and after two months of subdued job growth, economists are looking for Canada to add nearly 200K jobs. Strong data will justify the Bank of Canada’s decision to taper in April and set the stage for a further reduction in asset purchases later this year. The sell-off in oil and recovery in the U.S. dollar caused the Canadian dollar to shrug off a stronger IVEY PMI report but a good jobs number will be difficult to ignore.

The Australian dollar gave up earlier gains to end the day lower versus the greenback. Data continues to disappoint with the services PMI index dropping to 57.8 from 61.2. These reports reinforce the central bank’s plans to keep interest rates unchanged for the next few years. With no major U.K. data on this week’s calendar, sterling is also in a tight range.  

Regards,
Kathy Lien Managing Director of FX Strategy BK Asset Management 

http://www.bkassetmanagement.com/