FOMC minutes support USD, political turmoil pushes Aussie down

Summary:

• FOMC minutes pointed to further gradual rate hikes while officials had discussed the yield curve flattening

• US tariffs on $16 billion Chinese goods take effect on Thursday

• Australian dollar declines as PM Turnbull’s leadership could be challenged

The US dollar is regaining its power this morning fuelled by a belated effect of FOMC minutes released on Wednesday. In general, the FOMC minutes did not offer too many new signals with regard to the future monetary policy, some interesting points were made though. Obviously, a majority of members agreed that they expected further gradual rate hikes (in our view the Federal Reserve will deliver two more rate hikes - September and December - and both moves have been already discounted quite notably). On top of that, the Fed discussed the ongoing yield curve flattening albeit no details were offered in this context. Interestingly, many participants noted it would likely be appropriate in “not-too-distant future” to no longer refer to a monetary policy stance as accommodative. On the dovish side, most of participants shared the same view that ongoing trade disagreements and proposed trade measures are important downside risks to the economy. Moreover, officials voiced quite contradictory opinions regarding fiscal policy as the first group of members seemed to be quite myopic saying that it created a boost and upside risk to the economic outlook, while the second group focused on the long-term backdrop underlining a downside risk to the economy.

After the EURUSD almost reached 1.1630 it reversed quite substantially. Bulls may look for any support levels nearby 1.1520, but having trade risks back on the table it is highly probable that the US dollar could be in a bid in the nearest future. Source: xStation5

Even as the US dollar lost momentum in a knee-jerk move following the minutes release, it managed to recover afterwards. Among reasons for the USD outperformance we may single out possibly renewed trade tensions as a new round of US tariffs (the 25% rate) on $16 billion of Chinese imported goods kicked in on Thursday. This is obviously a move which could prompt Beijing to retaliate with the same amount of duties. As far as the likelihood of future rate hikes in the US are concerned, market participants - based on Fed Funds Futures - assign more than 90% for a move in the following month, and nearly 60% to see the second move till December. Notice that the US yield curve has flattened since the minutes publication, and as a result the 2Y10Y spread has moved down from above 24 to below 22 basis points. The US dollar index is gaining almost 0.3% as of 6:59 am BST with the most impressive gain against the Australian dollar being beleaguered by political turmoil.

Australian political scene has experienced upheaval of the recent years compared to New Zealand and Canada. Source: Bloomberg

The Aussie dollar is by far the worst performing major currency this morning. It stems from the fact that subsequent three ministers resigned from their posts, including high-profile Finance Minister Mathias Cormann, leaving PM Turnbull's position hard to retain. Notice that Turnbull said on Thursday that he would only hold a leadership vote if he received a signed petition proving that the majority of his party no longer supported him. The petition already arrived, but Australian PM said that he would hold a meeting at midday on Friday to decide on his leadership. Turnbull said that his major challenger Peter Dutton, former Home Affairs minister, might not be even eligible to sit in the parliament, after local media reported that he may have violated constitutional restrictions over this family business investments. Let us remind that the incumbent Prime Minister already won the leadership vote earlier this week, but Dutton does not seem to back down. After subsequent ministers resigned Dutton’s chances top topple Turnbull may have increased. As a result of political chaos Turnbull decided to suspend the government until 10 September to try to resolve the crisis. The Australian dollar is losing over 0.7% as of 7:17 am BST albeit the bond market does not seem to be overly concerned about the crisis as the 10Y yield is sitting at 2.53% this morning being down just 1 basis point.

The Aussie slumped overnight on political turmoil as well as the overall US dollar strength fuelled by renewed trade tensions. Technically the pair could see a short-term bounce after testing 0.7285. Source: xStation5