USD: Post-minutes sell-off overreaction to Fed noise… but understandable - ING

Viraj Patel, Research Analyst at ING, suggests that this is arguably the most divided FOMC that they’ve seen since the central bank began normalising policy, with the number one debate being whether the current weakness of US inflation is transitory or transitional.

Key Quotes

“There are clearly two camps within the committee: those that prefer a wait-and-see policy approach given the uncertain inflation outlook and those that are happy to rely on traditional macro relationships like diminishing spare capacity (or above-trend growth) generating higher future inflation. We think that the US data in 2H17 will give us evidence of being somewhere in the middle, which supports our Fed outlook of announcing balance sheet plans in Sep, and then cautiously hiking again in Dec. Markets will want confirmation from the incoming US data before fully pricing in a Dec hike.”

“Still, we don’t think it’s profitable chasing broad $ strength on a Fed story; while there will be short-term tactical opportunities (like long USD/JPY), the Fed is just one of three factors weighing on the $. The other two are (a) signs that the US economic cycle is beginning to top out in the absence of any pro-growth fiscal stimulus and (b) what we see as a political risk premium or political uncertainty having an outright negative effect on the dollar. Both are how we rationalise the decoupling between USD crosses and short-term interest rate differentials – and why the Fed may just be a subplot for the dollar right now. The bottom line is that while the post-minutes $ weakness may be a slight overreaction to Fed noise, it is understandable noise given a split FOMC and uncertain US political backdrop. Look for DXY to remain supported by the 92.50/55 low.”