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U.S. Dollar Falls as FOMC Minutes Paint Bleak Economic Outlook

U.S. Dollar Falls as FOMC Minutes Paint Bleak Economic Outlook

2011-07-12 18:49:00
Christopher Vecchio, CFA, Sr. Currency Strategist

THE TAKEAWAY: FOMC Minutes Released > Dovish Commentary Suggests Further Easing > U.S. Dollar Bearish

The U.S. Dollar fell against a basket of currencies shortly after 18:00 GMT as the Federal Open Market Committee’s Minutes from their most recent monetary policy meeting suggested policymakers were particularly dovish on the state of the world’s largest economy. Indeed, the information reviewed at the June 21 to 22 meeting showed that “the pace of the economic recovery slowed in recent months and that conditions in the labor market had softened.”

In a further review of recent conditions, the FOMC noted that “The expansion of private nonfarm payroll employment in May was markedly below the average pace of job gains in the previous months” of 2011, “[T]otal industrial production expanded only a bit during April and May after rising at a solid pace in the first quarter,” while “growth in consumer spending declined in recent months from the already modest pace in the first quarter.”

Using these recent developments, it was clear that policymakers shared a very modest outlook on the state of the recovery, though that such growth was “likely to be somewhat slower over coming quarters than they had projected in April.” The dovish view on the economy was rooted in the “persistent weakness in the housing market, the ongoing efforts by some households to reduce debt burdens, the recent sluggish growth of income and consumption, the fiscal contraction at all levels of government, and the effects of uncertainty regarding the economic outlook and future tax and regulatory policies on the willingness of firms to hire and invest.”

Dow Jones FXCM Dollar Index 1-minute Chart: July 12, 2011

U.S._Dollar_Falls_as_FOMC_Minutes_Paint_Bleak_Economic_Outlook_body_Picture_1.png, U.S. Dollar Falls as FOMC Minutes Paint Bleak Economic Outlook

Charts created using Strategy Trader– Prepared by Christopher Vecchio

Following the release, the Dow Jones FXCM Dollar Index fell as markets seemingly digested the commentary as an opening for discussion on further easing. Indeed, the overall dovish tone of the report boosted risk-appetite, as further loose monetary policy could allow for a further depreciation of the U.S. Dollar, which has depreciated against every major currency since the second round of quantitative easing started in November. The index dropped from 9680.40 to a session low, at 9629.44 within the 20-minutes following the release. The index was trading at 9665.86 at the time this report was written.

In commentary that was largely ignored by the markets was the exit strategy outlined in the minutes. Considering the U.S. Dollar has depreciated across the board since the massive liquidity injections dating back to November, news that the FOMC was outlining its strategy to cut down its expanded balance sheet was projected to have been Dollar-bullish, upon such an announcement.

Below are the exit strategy principles, in their entirety:

  • The Committee will determine the timing and pace of policy normalization to promote its statutory mandate of maximum employment and price stability.
  • To begin the process of policy normalization, the Committee will likely first cease reinvesting some or all payments of principal on the securities holdings in the SOMA.
  • At the same time or sometime thereafter, the Committee will modify its forward guidance on the path of the federal funds rate and will initiate temporary reserve-draining operations aimed at supporting the implementation of increases in the federal funds rate when appropriate.
  • When economic conditions warrant, the Committee's next step in the process of policy normalization will be to begin raising its target for the federal funds rate, and from that point on, changing the level or range of the federal funds rate target will be the primary means of adjusting the stance of monetary policy. During the normalization process, adjustments to the interest rate on excess reserves and to the level of reserves in the banking system will be used to bring the funds rate toward its target.
  • Sales of agency securities from the SOMA will likely commence sometime after the first increase in the target for the federal funds rate. The timing and pace of sales will be communicated to the public in advance; that pace is anticipated to be relatively gradual and steady, but it could be adjusted up or down in response to material changes in the economic outlook or financial conditions.
  • Once sales begin, the pace of sales is expected to be aimed at eliminating the SOMA's holdings of agency securities over a period of three to five years, thereby minimizing the extent to which the SOMA portfolio might affect the allocation of credit across sectors of the economy. Sales at this pace would be expected to normalize the size of the SOMA securities portfolio over a period of two to three years. In particular, the size of the securities portfolio and the associated quantity of bank reserves are expected to be reduced to the smallest levels that would be consistent with the efficient implementation of monetary policy.

The report did note, however, that the FOMC is prepared to make adjustments to its exit strategy if necessary in light of economic and financial developments,” so the noncommittal tone summarizing the aforementioned policies likely contributed to their lack of bullish impact on the Greenback.

Written by Christopher Vecchio, Currency Analyst

To contact the author of this report or be added to his distribution list, please send inquiries to: cvecchio@dailyfx.com

Follow Christopher Vecchio on Twitter: @CVecchioFX

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