USD Declines as Fed Minutes Reiterate Dovish Shift in Outlook


Talking Points:

  • Markets mull over the Federal Reserve’s FOMC December 18-19 meeting minutes deliberating the weight it still carries after recent market developments
  • A data dependent Fed has turned increasingly cautious over its path to normalization due to deteriorating fundamentals and tightened financial market conditions
  • The minutes are released following recent dovish remarks from several key Fed officials causing the USD to drop

The Federal Reserve released its FOMC minutes from the December 18-19 policy meeting where the central bank raised its benchmark interest rate 25 basis points to a range of 2.25-2.50 percent. Since the decision, stocks and bonds have experienced a whirlwind of turmoil as investors gradually grow more pessimistic about the future. This has resulted in a massive selloff across asset classes as financial conditions tighten in response to a waning economic backdrop.

DXY INDEX PRICE CHART: 120-MINUTE TIMEFRAME (DECEMBER 17, 2018 TO JANUARY 09, 2019) (CHART 1)

DXY USD Index Price Chart After Fed Minutes Released January 09, 2019

Recent developments between fresh economic data and progressively more dovish remarks from Fed committee member speeches renders the FOMC minutes slightly outdated. Several economic gauges have deteriorated with some largely missing consensus expectations such as the ISM Purchasing Managers Index for both the manufacturing and services sectors.

The downshift of America’s economic engine has resulted in the Federal Reserve updating its Summary of Economic Projections which lowered estimates for GDP, inflation, and the midpoint target for the federal funds rate. Additionally, the Fed has taken a more aggressive approach to communicating its commitment to data dependency as participants remain open to holding off on more rate hikes seeing that the Fed is not on a preset course.

This has been conveyed most powerfully by Fed Chairman Jerome Powell who last Friday reassured markets that the central bank has the back of investors should the financial situation turn sour. At an interview at the American Economic Association, Powell commented that the Fed can be “patient as we watch to see how the economy evolves” especially with the subdued readings of inflation witnessed.

Furthermore, this has been echoed by Federal Reserve Bank District Presidents Eric Rosengren and Raphael Bostic who both touched on the idea of the Fed listening to the financial market’s reaction to monetary policy tightening and current risks which have plagued investor risk sentiment. Most prominently, the discussion over the tapering of the Fed’s balance sheet is now on the table for discussion – a change that could pose a material shift to how markets anticipate the Fed’s conduct of monetary policy and path to normalization.

FED FUTURES IMPLIED INTEREST RATE HIKE PROBABILITIES BY DECEMBER 2019 PRICE CHART: DAILY TIMEFRAME (JUNE 01, 2018 TO JANUARY 09, 2019) (CHART 2)

Fed Futures Implied Rate Hike Probability Price Chart by December 2019

With the prospect of future rate hikes quickly vanishing from the minds of market participants with the dovish drumbeat growing louder, the USD has been depreciating accordingly. The Fed at one time projected up to four interest rate hikes for 2019, but now only forecasting closer to two while money markets on the otherhand are starting to price rate cuts for this year.

FOMC Minute Key Takeaways

Though financial conditions had tightened and Federal Open Market Committee global growth had moderated, members generally anticipated that growth would remain above trend and the labor market would remain strong.

Several participants expressed the view that it might be appropriate over upcoming meetings to remove forward guidance entirely and replace it with language emphasizing the data dependent nature of policy decisions.

“The tightening in financial conditions so far did not appear to be restraining real activity, although a more persistent tightening would undoubtedly weigh on business and household spending.”

“Risks to the outlook appeared roughly balanced, although some noted that downside risks may have increased of late.”

Fed Target Federal Funds Rate Projection for 2018 and 2019 Price Chart

Written by Rich Dvorak, Junior Analyst for DailyFX

Follow on Twitter @RichDvorakFX

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