The USD 2018 rally was always unlikely to continue to into 2019. However, the release of the January Fed Minutes suggests that USD’s likely ‘moderation’ in 2019 may actually turn more bearish move.

The Fed has clearly been spooked by the market, the movements in the bond market in particular has moved the dial. Then there are the ‘risks’ in the US economy which are pointing to slowing growth. All this is has seen the Board move almost 180 in its views on the Fed Funds rate and its view on GDP.

However, what has become clear from a currency perspective is possible actions that this 180 might cause the Fed to do 2019.

Here are the four key points from the January FOMC meeting that are USD sensitive:

  1. Most member stated growth as ‘solid’ down from the ‘strong’ and expect growth to “step down somewhat” due to: softer sentiment, a weaker global outlook, and ‘materially tighter financial conditions’. This final point has been a clear trigger for the market to starting to discount rises in the Federal Funds rate.
  2. Inflation ‘remained near 2 percent’ however the Minutes note members discussed recent “softness” in inflation is now persisting, and the ‘hoped’ upward inflation is not ‘more muted’. The Minutes also note that market-based measures of inflation had lowered in recent months, yet survey-based measures of inflation expectations were ‘little changed’. This is the Fed mandate that has realistically never been meet and again feeds into why the Federal Funds rate is likely to remain on hold for 2019.
  3. Most members agreed with replacing its hiking bias communication with a ‘patient and flexible approach’. Again, the reasoning: tighter financial conditions, softer inflation, slower foreign growth, and trade policy uncertainty as justifying a patient approach to policy. But what did differ was the adjustment to the Federal Funds rate in the back end of the year ‘several’ members stated increases were necessary ‘only if’ inflation was higher than in their ‘baseline’ (aka 2%) while ‘several’ others indicated that hikes would be appropriate if the economy evolved as they expected. Suggesting that we now have a split on the board around rate rises. The baseline however is rates are on hold with a slight hike bias – a mild USD positive.
  4. The balance sheet: this was the most interesting part of the statement, almost all Board members thought it would be necessary to announce that the FOMC will stop reducing the Fed’s balance sheet sometime in the backend of this year. The balance sheet topped out at US$4.5 trillion its likely to be US$4 trillion in size come June. This is substantially bigger than forecast and ‘enormous’ when compared to the balance sheet pre-GFC. The suggestion from members was that Quantitative Tightening (QT) might be influencing financial markets, and thus policy needs to be ‘flexible in principle’. The end of QT at a much higher level than forecasted suggests market ‘support’ is not out of the question – USD dampener.

Based on all of this, one would expect the Fed to announce these ‘changes’ to policy in the upcoming March meeting. This would put a weight into USD G10 pairs – pencil this event into the diary now.

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