FOMC minutes and data another lift for the dollar

USD: Fed minutes & data help extend dollar gains

The US dollar advanced by about 0.6% on a DXY basis yesterday and is now 1.2% stronger from the low hit on Wednesday of last week. The move yesterday was notable with the data released on durable goods, housing and industrial production all stronger than expected. The minutes released last night certainly have helped reinforce expectations that the FOMC could be on hold for a longer period with views on the labour market clearly improving. That was reflected in the statement in January which included the view that the unemployment rate had shown signs of “stabilization”. The minutes indicated that “the vast majority” of participants had judged that downside risks to employment had moderated. We are somewhat surprised that such a large cohort hold that view given by the time of the meeting there wasn’t compelling evidence to back that up. Of course following the stronger NFP data that view is likely now held with more conviction. “Several participants” were reluctant to support rate cuts in the context “of elevated inflation readings”. An FOMC cut is now not fully priced until July with two cuts for the year. Inflation therefore remains key. Our view is that much of the tariff-related lift to inflation is likely already in the data and that 2026 could see tariff rates drift lower given the mid-term elections in November.  The India tariff has been cut from 50% to 18% and there have been comments from officials suggesting they are considering tariffs on metals being reduced. In that context and given the evidence of wage disinflation (in the ECI data), we fully expect further deceleration in inflation toward the 2% target.

The US dollar has also derived support from a renewed escalation in geopolitical risks. Crude oil gained over 4% yesterday – it’s biggest one-day gain since October on reports that a US military attack on Iran could come sooner than expected. An attack would see further gains that would quickly see energy-importing countries suffer with the yen and the euro currencies that could suffer. NOK is the top performing G10 currency year-to-date with crude oil prices up over 15% from the low in January.

The yen would certainly be an under-performer in response to an attack on Iran. USD/JPY is now close to three big figures higher from the low last Thursday and suggests that the short yen positioning liquidation following the election victory for PM Takaichi is complete. PM Takaichi will give a key policy speech tomorrow and the details were summarised in a Nikkei news article and conveyed a continued focus on managing fiscal policy prudently. If that’s one of the key takeaways of the speech tomorrow it should help JGB sentiment. A 20-year JGB auction today, which revealed a weaker bid-to-cover ratio did not prompt selling and superlong yields are lower underlining the better JGB sentiment. That will help limit yen downside risks if geopolitical risks and energy prices were to escalate further from here.  

US DOLLAR MOVEMENTS BACK IN LINE WITH RATE SPREAD MOVES

Source: Bloomberg, Macrobond & MUFG GMR

USD: Fed board divisions ahead & independence doubts

US dollar sentiment in January was terrible – as bad as we can remember in a long time. Metals surged in value amid concerns over US dollar debasement, geopolitical risks and general Trump policy unpredictability. The announcement that Kevin Warsh would be Trump’s nominee for Fed Chair helped ease some of these concerns and dollar sentiment has certainly improved since. As stated above, the stronger US economic data and FOMC minutes yesterday have seen US dollar gains extend further.

But we remain unconvinced that these risks have gone away and sentiment on the dollar is set to remain fragile, probably for as long as Trump remains in the White House. We saw another example yesterday of the way in which the White House will continue to interfere with the independence of the central bank. Kevin Hassett, National Economic Council Director, described a New York Fed research analysis piece as “an embarrassment” and that the authors should be “disciplined”. The piece made the conclusion that 90% of the economic burden of tariffs had been borne by US companies and households. As of November, export price declines were deemed to have accounted for 14% of the tariff impact implying a still hefty 86% passed through to US companies and households.

Our hunch is the Trump administration knows this. The India tariff rate cut from 50% to 18% and the speculation that tariffs on metals will soon be reduced as well are evidence of the Trump administration looking to address this issue. In a mid-term election year, the administration will need to lower the inflation impact and the average effective tariff rate is more likely to fall than rise this year.

The arrival of Kevin Warsh as Fed chair could also mark the start of greater divisions within the board of Governors. On Tuesday comments from SF Fed President Daly and Governor Barr suggested they saw reason to believe AI could result in a higher long-run rate for economic growth that required higher rates. Kevin Warsh has indicated he sees AI as driving a productivity surge that allows for lower rates. Board of Governor dissents have been rare since as long back as the early years of the Greenspan Fed and increased dissents of Governors would likely be viewed by investors as a sign of the increased political influence on the Fed. Kevin Warsh will still push for rate cuts while also argue the need for a smaller balance sheet. While balance sheet policy changes will likely take longer (bank regulation changes required first), the implication of this policy mix would be a steeper yield curve that historically tends to coincide with US dollar depreciation.

FOMC VOTING DISSENTS BY CALENDAR YEAR – GOVERNORS & PRESIDENTS – GOVERNOR DISSENTS HAVE BEEN RARE SINCE MID-1990’S

Source: Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com