Discussion and Analysis by Charles Porter:
Yesterday evening, at 19:00BST, the minutes from November’s Federal Open Market Committee (FOMC) meeting were released. A December rate hike in the US is already heavily priced in by the market and widely taken for granted. Yesterday’s release affirmed this sentiment, confirming the members’ commitment to raising the target interest rate band next month. What is equally important to the value of the US Dollar and the shape of the US yield curve is future monetary policy expectations. These were weakened by the release and, accordingly, the US Dollar lost considerable value. The Dollar has continued to struggle on currency markets this morning, losing 1% against the Euro week-to-date.
The minutes show that Janet Yellen’s more dovish comments, that were expressed during her public conversation with Sir Mervyn, are shared by the entire FOMC. The minutes revealed that members are concerned inflation has disappeared for longer than previous envisaged. With some market participants pricing in up to four US rate hikes next year, the news was negative for today’s US Dollar. Frequently, individual agents within bond and currency markets have demonstrated distrust in the forward guidance of the Federal Reserve, basing their engagement with markets upon the assumption of as few as two US rate hikes in 2018.
Speaking to New York University’s Stern School of Business, Federal Reserve Chair Janet Yellen explained that inflation was more illusive than had been previously envisaged. One conclusion from this was that the concerningly low inflation that has currently plagued global economies may not just be transitory. Yellen said that “there may be something endemic here that we need to pay attention to”.
A concern about price and wage inflation at times of hyper-low unemployment and strong economic growth was the overwhelming take-away message from the FOMC minutes. Due to the concurrent headwind that the US Dollar is facing caused by a turbulent congressional hearing of Trump’s tax reform bill, the Greenback has struggled to find a footing.
Monetary policy is crucial to the value of a currency because interest rates determine the reward for saving or holding it. Similarly, although quantitative easing was not the subject of the FOMC minutes, it too determines the money supply in the economy and, therefore, the clearing value of the domestic currency.
The more ‘dovish’ reading that appeared within the minutes entails that there are greater inhibitions within the monetary policy setting committee to raising interest rates and, thus, the rate of return on savings. The mixed message was derived from the FOMC’s continued commitment to raising rates this December amidst a warning of medium term interest rates.
The curve, the difference between 2 and 10- year yields on sovereign debt, flattened upon this news reflecting the expectation of tighter monetary policy in 2018. During an episode of near-term interest rate hikes, it is inevitable that the curve flattens slightly because all points are dragged to a new yield. However, given that near-term forward guidance was unchanged, this flattening represents an underlying concern and disbelief in the forward looking intentions of central bankers.
It appears then that the federal reserve once again turns to a more data-dependent stance on monetary policy. This move has the effect of increasing currency market volatility to episodes of hard data, making fluctuations in the currency more severe. Ahead of 2018, we look towards December’s monetary policy decision to understand more about the future path of interest rates.