US Dollar Aims Higher as FOMC Minutes Fuel Rate Hike Bets

Talking Points:

• US Dollar outperforms as hawkish Fed-speak boosts rate hike bets
• April FOMC minutes may send USD higher, trigger risk aversion
• UK jobless claims, revised Eurozone CPI figures likely non-events

The US Dollar outperformed in overnight trade, rising against its major counterparts amid building Fed rate hike speculation. Indeed, the benchmark currency advanced in lock-step with front-end US Treasury bond yields. The move follows hawkish comments from John Williams and Dennis Lockhart, Presidents of the Federal Reserve’s San Francisco and Atlanta branches, respectively.

Both Lockhart and Williams argued in favor of two to three interest rate hikes in 2016, with the latter even going so far as to say policymakers’ references to “gradual” tightening imply this plus three to four increases in 2017. Lockhart went on to say that opinions on the FOMC are in a “pretty tight range” – signaling that his hawkish lean represents a majority of officials – and added that he doesn’t rule out raising rates before June’s “Brexit” referendum. Williams stated point-blank that, based on the data, raising rates makes sense.

The Fed’s aggressive call for four 2016 rate hikes as it began outright tightening in December 2015 spooked investors pricing in just two increases. This triggered risk aversion that echoed back into policy bets, fueling a dovish shift. In March, the Fed appeared to recognize its communication error and went about fixing it, slashing the 2016 outlook to match what investors had been comfortable with prior to “liftoff” (50bps in hikes) and blaming the slump in sentiment on external threats (lest admitting to a misstep tarnishes the central bank’s credibility).

Last month, the Fed’s policy statement pointedly de-emphasized outside headwinds and subsequent official commentary began to build toward an increasingly hawkish tone. The aforementioned remarks from Lockhart and Williams amounted to the strongest language yet from the mainstream core at the heart of the policy-setting apparatus. Taken together, this looks like a coordinated effort to realign official and market-based rate hike bets to make for smooth resumption of stimulus withdrawal.

The upcoming release of minutes from April’s FOMC meeting is the next critical inflection point in this narrative. Rhetoric suggesting that the markets are underestimating the US central bank’s determination to raise rates again in the near term as well as the extent of tightening on tap this year is likely to encourage continued gains for the greenback. It may likewise trigger risk aversion, threatening to deliver outsized losses to the sentiment-linked Australian, Canadian and New Zealand Dollars.

On the European data docket, UK Jobless Claims data seems unlikely to inspire a significant response from the British Pound considering the outcome’s limited implications for near-term BOE policy trends, especially with the “Brexit” vote on the horizon. Revised Eurozone CPI figures are also likely to pass with little fanfare as the ECB remains in wait-and-see mode, waiting to gather sufficient evidence to judge the efficacy of the gargantuan stimulus effort it launched earlier in the year.

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

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