It seems today’s FOMC meeting minutes is one for the fixed income traders as opposed to the FX space.
While the yield curve has risen on what can only be described as a more hawkish outlook on policy normalisation, the impact of front-end rates cracking through 0.8% has yet to give the dollar a solid bid in the G10 space despite its meteoric rise at the beginning of the year resulting in a broad USD bid. The lack of action in the dollar, even against low yielding currencies like JPY that have suffered thus far during the repricing in the Treasury market, is notable and suggests that the linkage earlier on this week was largely driven by a reversal in the dollar’s fortunes at year-end as opposed to a yield driven dynamic.
The most notable development in the minutes undoubtedly came in the form of the Fed’s view on balance sheet reduction.
While some preference towards earlier quantitative tightening was visible, the view of a similar lag to that in 2017 (i.e. two years after rate lift-off) remained the status quo. However, most participants noted that due to the larger accrual of assets and the ample liquidity in money markets, quantitative tightening will likely take a more aggressive role in the normalisation process this time around. Additionally, their view on the flattening of the yield curve and the impact that will have on financial stability was notable. Participants noted that balance sheet reduction could combat the flattening of the Treasury curve during the normalisation process, which poses risks for financial intermediaries and thus financial market stability. The inclusion of such analysis helped back-end yields follow the front-end higher upon the release of the minutes; a dynamic that has largely been absent since the hawkish shift back in December.
For FX markets, the impact of today’s meeting minutes will likely play out over the course of the week, especially as December’s jobs data is released on Friday following bumper ADP and Homebase indicators earlier in the week.
With several participants noting that the maximum employment objective has largely been met, and uncertainty over the recovery in the participation rate in the coming months, jobs data will be key in determining whether the growing consensus in money markets for lift-off at March’s meeting is the correct bet. In this sense, today’s meeting minutes were merely additional kindling in the bonfire that is building underneath the FX fireworks. The question is, what jobs report will provide the spark?
Author: Simon Harvey, Senior FX Market Analyst