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FOMC minutes show split committee amid weak inflation
Fed minutes leave markets hopeless
Investors were impatiently waiting for clues about the Fed’s thinking. Quite the contrary, the minutes of the last FOMC meeting showed a highly-divided committee, increasing the overall uncertainty about the timing of the next interest rate hike and the beginning of balance sheet unwinding programme.
The committee noticed that the labour market continued to strengthen together with the economic activity, the latter improving at a moderate pace though. FOMC members acknowledged both headline and core inflation measures came in below their anticipation but “viewed the recent softness in these price data as largely reflecting idiosyncratic factors” and added that it will have little bearing effect on the medium-term. However, some participants appeared quite concerned about the downside risk in inflation and raised doubts about reaching the 2% target, suggesting that dissent started to appear within Fed presidents.
We reiterate our view that the weakness in inflationary pressures that has emerged at the beginning of the year will force the Fed to slow down the pace of monetary tightening. Therefore, we expect only one other rate hike this year, most likely in December. We also anticipate that the Fed will wait until December to announce the timing of the balance sheet reduction, which will most likely start at the earliest in the second half of 2018.
Given the lack of new information provided by the minutes, the USD was little changed on Thursday. EUR/USD consolidated around 1.1350, still trading with a negative bias as investors catch their breath after last week's euro rally. The pound sterling moved in a similar fashion as markets awaited fresh news regarding the Brexit negotiations, with GBP/USD treading water below the 1.30 threshold.
Fade rising tensions
The wires continue to push rising geopolitical tensions and for good reason. Between the US Ambassador to the UN Nikki Haley's harsh warning to countries enabling trade with North Korea and US President Trump’s aggressive tweets against China, it feels as if rhetoric has reached a new high.
It’s likely the US will enact further sanctions on North Korea in the coming days and the possibility of a trade war with China has increased significantly. Like clockwork, FX markets shifted into safe haven JPY buying and KRW selling, with regional trade dependent currencies also weaker.
However, there is also the feeling that we have been here before under the Trump administration. The strategy of pushing advisories/issues to the edge only to back off at the last minute are hallmark Trump. So despite the threat of war, implied volatility in FX markets have been in decline for the last few days.
In our view, this shift has created an opportunity in FX EM. The macro story of solid external demand, higher interest rates, and low expectations for protectionism to stymie trade will continue to drive carry trades. We have consistently expressed that the key to 2017 will be to filter out the hype, and the current environment is a prime example.