• Fed makes a subtle point to keep September rate hike possibilities open The dollar initially fell following the release of the statement following the FOMC meeting. Although the discussion of the labor market showed more confidence than in June (“further improvement in the labor market”), the conclusion remained that “the Committee continues to see the risks to the outlook for economic activity and the labor market as nearly balanced.” With no change there, investors thought no change overall and sold dollars.
• However, then people noticed a very subtle change: in discussing the future path of rates, the statement changed “improvement” to “some improvement,” making the criteria for hiking a bit more vague. It now said that the committee expects to raise rates “when it has seen some further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.” Adding the term “some” lowers the bar for what constitutes improvement. It will make it easier for the Committee to justify a September tightening if they want to. As a result, fed funds rate expectations rose and the dollar firmed against all the G10 currencies and most of the EM currencies that we track too (the two exceptions being RUB, which recovered somewhat along with oil, and BRL, which gained along with commodities in general).
• While labor market indicators are improving, the inflation outlook hasn’t changed that much. Inflation expectations continue to decline, despite what the Fed says, and the core personal consumption expenditure (PCE) index, the Fed’s preferred inflation indicator, still runs far below target. (That will be a major point of interest later today when the Q2 GDP figures are released – see below.) Nonetheless, I continue to believe that the FOMC is determined to hike this year if at all possible and will do so unless there is some external catastrophe. Their point is that zero interest rates are an extraordinary policy setting that is only appropriate for an emergency, and that emergency no longer exists. The start of a hiking cycle should be positive for the dollar, if history is any guide.
• NZD is worst-performing currency How quickly sentiment turns! NZD had been the best-performing G10 currency when I was writing yesterday morning, but it’s been the worst-performing one over the last 24 hours. The enthusiasm apparently peaked shortly after Gov. Wheeler’s speech and the currency has steadily declined ever since. There doesn’t seem to have been any single trigger, just apparently people shared my view that the external situation wasn’t likely to change and therefore Gov. Wheeler was right – the currency is likely to decline. As Chinese imports of milk decline, Fonterra Cooperative Group Ltd., the country’s (and the world’s) largest dairy exporter, Thursday slashed its payments to New Zealand farmers almost in half, to NZD 4.40 per kg of milk solids from NZD 8.40 a year earlier. This is below the break-even level for most of the country’s 12,000 farmers, estimated at the low NZD 5.00/kg level. Another NZ milk company is forecasting a payment of less than NZD 4.00 for the current season. This fall in farm incomes is likely to cause considerable distress in the sector and makes further rate cuts more likely. It’s a big negative for the currency.
• Oil rose as US production fell and inventories declined in the latest reporting week. However, I would argue that with the US rig count going back up and the Iran settlement likely to be implemented, the supply picture is still negative for oil. I expect oil prices to decline further and for the oil-related currencies to remain under pressure.
• Today’s highlights: During the European day, the German CPI for July is coming out. As usual, we will look at the larger regions for a guidance on where the headline figure may come in and thereby as an indication for the near-term direction of EUR. A rise in the German CPI rate could indicate a rise in the Eurozone’s CPI to be released on Friday and strengthen EUR a bit. The country’s unemployment rate for July is also coming out.
• In Sweden, the preliminary Q2 GDP is expected to show that the economy expanded a bit from Q1. Coming on top of the dip of the CPI back to deflation, a strong growth figure is needed to stave off pressure from the Riksbank to take further action.
• From Norway, retail sales for June are expected to rise, a turnaround from the previous month. This could prove NOK-supportive.
• In the US, the 1st estimate of Q2 GDP is expected to show that economic activity bounced back after slowing in Q1. This is in line with the Fed’s expectations for a stronger Q2 growth, and could provide a boost to USD. The annual revisions to GDP will also be released to data between 2012 and Q1 2015. As such, investors will be looking not only at the Q2 estimate, but at the revisions as well. We have mentioned several times that the dollar is becoming increasingly data-driven and significant positive data surprises are likely to keep USD in a bullish trend. The 1st estimate of the core personal consumption index, the Fed’s favorite inflation measure, is also coming out. Initial jobless claims for the week ended July 25 are also due to be released.