St. Louis Fed President, James Bullard, a supposed hawk, has been bullying the "single" currency bears into temporary submission ahead of today’s FOMC meeting minutes or at least he should be held responsible for getting the ball rolling. Yesterday, he suggested that the most appropriate policy for the Fed is to continue the current QE3 policy. Dovish comments from the voting hawk has put the "mighty" dollar under pressure when the market least expected it when he mentioned adjusting the pace of purchases in view of incoming data on economic performance, employment and inflation.
The only thing that Mr. Bullard purposely refused to acknowledge yesterday was when the Fed might be tapering off its purchases. Bullard went on to say that like Japan, Europe risks an “extended period of low growth and deflation unless the ECB acts with an aggressive quantitative easing program.” To date, the ECB has been lending banks “unlimited funds” for up to 3 years and pledged to buy bonds of countries engaged in economic adjustment plans – eurozone policy makers have never committed themselves to wholehearted bond buying, unlike the BoJ, which maintained its asset purchase plan earlier this morning without any mention of the recent rise in JGB yields in its monetary policy statement.
Japanese policy officials acknowledged the rise in inflation expectations in its post meeting statement and argued that a “high degree of uncertainty about the economic outlook remained” – hence maintaining its current AP plans. Importantly, with policy members not mentioning higher JGB yields, it implies that they are somewhat comfortable with the market pricing in future “inflation expectations.” Overall, the market took away a “dovish statement” and a central bank having no immediate intent to “move away from easing rapidly upon indicators of inflation improving.”
Some investors are anticipating that the release of this afternoon’s FOMC minutes will indicate that both the Fed’s "hawks and doves" are beginning to become “increasingly uncomfortable with the current $85 billion a month asset purchase pace.” The possibility of perhaps varying the monthly QE sizes may reduce the potential for an “outsized market reaction to any given adjustment.” Ideally, it seems that investors are looking for confirmation of the expectations that the Fed is considering a reduction in asset purchases – the primary reason of late for the “mighty dollar” strength specifically against the antipodean currencies and Prime Minister Abe’s yen.
The FX market will focus on the FOMC minutes and on the Bernanke testimony, looking for confirmation of the expectations that the Fed is considering a reduction in asset purchases. There is the potential for disappointment (especially from helicopter Ben’s testimony), as the "man" himself might highlight the “mixed tone of recent data, split between improving employment and rising risk of disinflation.” Under this scenario, the "mighty" dollar may find it difficult to find immediate local support.
For the rates specialists in fixed income, they will be focusing firmly on whether there are any hints of “what criteria would trigger an adjustment to asset purchases, and how serious the discussion around adjusting purchases were at this month's meeting”. The plethora of Fed speakers already this week has been showing a willingness to emphasize a “desire to maintain flexibility, particularly until the labor market data for this month becomes available.”
Anyone hoping that Ben will talk about tapering may become more frustrated by day’s end. Helicopter Ben is due to leave office by year-end and like most rational individuals, he will not want to upset the “apple cart” or his legacy. The predominate reason behind the QE scale back is a market somewhat pinning its hopes on some regional Fed governor's rhetoric – in the real world, these individuals have little power to influence the FOMC decisions and on better jobs data. However, the employment argument should be seen as a mute one. The U.S. unemployment rate at +7.5% is still too high for Ben and his cohorts.
The forex market was expected to be relatively calm until the FOMC and Bernanke show their hand later this afternoon. However this is not so as sterling and U.K. gilts have borne the brunt of this market's frustration after reported weaker U.K. data rather than the Bank of England May minutes. GBP has been forced to retreat below its April 4th low after softer than expected U.K. retail sales report that experienced a -1.4%, m/m, drop ex-fuel. The weather was somewhat to blame and so, too, were food sales falling an aggressive -4.1% on the month. The BoE minutes showed very little in new information. Yesterday’s U.K. inflation report provided much more detail on the BoE's current way of thinking, more so than today’s minutes release. The weaker retail sales headline cannot be considered a slam-dunk for more QE, as the report has been very volatile of late.
Outgoing governor of the BoE, Mervyn King, has maintained his stance that the U.K. economy would benefit from more stimuli. Again this morning he was in the minority, 3-6, seeking to extend the central bank’s￡375-billion AP program by another￡25-billion. The committee voted 9-0 to keep the overnight benchmark interest rate at +0.5%. The majority believes current monetary policy remains “exceptionally accommodative.”
This market is content pre-trading a weaker dollar announcement and lifting the single currency to new heights. It seems that majority of investors are happy for Ben to remain broadly dovish – a weaker dollar in general. If he indicates a possibility of some tapering in the coming months or if the market interprets his comments as such, this weakening dollar bias will be quickly reclaimed and the "mighty" dollar can stand tall again.