Dollar hit by Fed concerns ahead of WB IMF Meetings

And just as markets began to suspect the Federal Reserve had run out of tricks in propping equities and capping the rapid rise in the US dollar, the minutes of the Sep 16-17 FOMC meeting dropped a surprise; the Fed takes a page from the past and mentions the rising dollar as a risk to exports and growth. The Fed has previously referred to the dollar as an inflation-dampening force, but not as a risk to growth — at least not in the last three years.

Dollar focus distracted by yields

The 10% and 7% rise in the dollar against the euro and yen this year was accompanied by advances of similar magnitude against other currencies, suggesting the central bank is already getting a taste of the potential currency repercussions of ending QE late this month. The Fed has spent so much energy in talking down yields — successfully — that it had overlooked the dollar.

Great timing for currency wars at the IMF/World Bank meetings

While journalists will not let this opportunity go by without readdressing the topic of currency wars and central bank-driven currency devaluations, policy makers will do the same, albeit discreetly at this weekend’s annual meetings of the IMF and the World Bank in Washington.

At a time when the yen’s broad plunge forced Japan’s finance minister to mention the negative impact of excessive yen weakness on energy imports, the Fed is now checking the other side of the problem, that of excessive strength.

As G8 nations and the IMF/WB forum gets under way, expect more statements from central bankers and finance ministers with regards to monetary policy, which could carry “currency side effects”.

Draghi & his former professor

ECB president, Draghi, is due to speak on Thursday at 11:00 ET (16:00 BST), followed by Fed vice chairman Stanley Fischer (not to be confused with Dallas Fed’s Fisher), who was Draghi’s PhD thesis advisor at MIT.

A host of other Fed speakers (Tarullo, Lacker and Williams) are also set to speak later in the day. Rest assured that questions over the role of euro weakness in pre-empting disinflation and USD strength in halting a nascent US recovery will emerge.

Dollar & the Fed doves

The current pullback in the US dollar began well before Tuesday’s statements from the Fed’s dovish members, dampening prospects of a near-term rate hike and reiterating the case for low interest rates. But the combination of dovish Fedspeak and partial unwinding of excessive build-up in USD long positioning cannot go unnoticed.

EUR/USD regains $1.2680s as overstretched EUR/USD shorts (three straight monthly declines) and a simultaneous 15% reduction in net EUR/USD positioning shorts in the CME’s futures contract drive the short squeeze. Monday’s 139-pip rally in EUR/USD was the biggest daily point rally since 23rd January.

Dudley & Kocherlakota

A more fundamental reason has been Fed speak, with remarks today from Minneapolis Federal Reserve Bank President Kocherlakota indicating it would be “inappropriate” for the Fed to raise short-term rates anytime next year, due to the low level of current and projected inflation.

Kocherlakota’s comments were in line with those made earlier in the day by NY Fed’s Dudley: stating his support for the Fed’s large-scale asset purchase program later this month but indicating that “it’s still premature to begin to raise interest rates” because the labour market “still has too much slack and the inflation rate is too low”.

This all means that influential Fed members are shifting their focus away from jobs and back towards inflation as a way to re-affirm that rates will stay low, thus offsetting any hawkishness from the removal of QE.

Further corrective rebound in EUR/USD appears inevitable. If the latest positive correlation between USD and stocks indices continues, then our anticipation for further selloff in equity indices, suggests further corrective pullback in USD.