US Dollar Looks to FOMC Meeting Minutes to Fuel Recovery

Talking Points:

• Aussie Dollar gains, Yen trades lower as risk appetite firms in Asia
• Minutes from March FOMC meeting in focus for financial markets
• US Dollar may rise as the Fed’s tone on external headwinds softens

The Australian Dollar traded higher alongside Asian stock exchanges while the anti-risk Japanese Yen declined as sentiment firmed overnight. The moves appeared corrective in the context of risk aversion yesterday, which probably reflected pre-positioning ahead of the upcoming publication of minutes from the March FOMC meeting.

Investors’ 2016 rate hike outlook has shifted in the dovish direction over the past two weeks. The minutes represent event risk with potential to counter this dynamic, which seemed to inspire preemptive unwinding of thematically-linked exposure yesterday. Investors’ concerns may prove well-founded (as we expected).

The FOMC slashed its 2016 rate hike outlook and stressed threats posed by external forces as the reason for delaying tightening last month. The latter sounds like code for risk aversion triggered by the Fed itself after it projected four rate hikes this year versus the markets’ bets on two ahead of December’s “liftoff”, especially since headwinds cited by officials (weakness in crude oil and the US Dollar, the slowdown in China) did not strengthen in the first quarter. Within that context, the former looks like retreat to a tightening path that can be on-boarded by investors without another market rout.

Critically, the Fed must now convince traders that recent improvement in US economic news-flow ought to translate into firmer policy bets. Markets now price in just one 25bps rate increase this year, and policymakers need that to return to December levels to comfortably hike in June. Firm data began to boost baseline expectations in February but the relationship broke down amid speculation that the Fed’s fears of external dangers would delay hikes regardless of domestic performance.

Having established a narrative to justify inaction last month, officials must now deal with this side-effect by clearly signaling that the cross-border threats they are monitoring have not materialized thus far and may never do so. Making this plain may help shift the spotlight back to US economic data as an end-all measure of both domestic and foreign-born influences on the business cycle and the policy trajectory. If successful, this may bode well for the greenback while risky assets and gold prices face renewed selling pressure.

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--- Written by Ilya Spivak, Currency Strategist for DailyFX.com

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