2 Reasons Why USD Damage Is Limited From Here

[thenews]

In the US, the July FOMC minutes disappointed those looking for a more explicit hawkish signal after Tuesday’s comments from NY Fed President Dudley. The minutes contained the usual diverging views between the doves and the hawks on the committee but the bottom line is that the majority felt it was appropriate to wait for additional information before considering the next move. As for the reference to diminished near-term risks in the statement, the minutes contained few clues about how much further those risks need to fall to validate a rate hike.

Despite the initial market reaction we believe the damage to the USD should be limited.

First, Dudley’s comments may actually be closer to the current mood on the FOMC given that there has been one more strong jobs report since the meeting.

Second, despite somewhat confusing communication this week, Fed appears to be putting a floor under tightening expectations. One of the dangers of allowing expectations to turn excessively dovish is that any attempt to hike would then trigger a sharp rise in real rates, undermining risk sentiment. We believe the Fed would be keen to avoid this as long as it does intend to tighten this year.

While our economist believes the door to a hike as soon as September remains open, it will likely be open much wider in December when we see the Fed raising the fed funds rate by 25bp. Both Dudley and Williams will get an opportunity to fine-tune their messages on Thursday. For Williams in particular, this will be a chance to clarify whether his discussion of long-term challenges surrounding the Fed’s 2% inflation target has implications for his current policy outlook.

Overall, we believe the USD remains cheap relative to rate differentials, particularly against the G10 commodity currencies.

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