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Dovish Fed Minutes Leave Currency Markets Unmoved

Karl Schamotta January 3, 2020

Officials at the world’s most powerful central bank remain concerned about downside risks, and plan to keep interest rates on hold this year. A record of the Federal Open Market Committee’s December 10-11 meeting, released this afternoon, showed that policymakers remained worried about price growth running well below the bank’s 2% target. “Various participants were concerned that indicators were suggesting that the level of longer-term inflation expectations was too low” – and fear of an inflationary overheat was non-existent: “No participant assessed the risks to his or her inflation outlook as weighted to the upside”.

But the economy was expected to remain resilient, and a “number of participants noted that the labor force participation rate could rise further still” – suggesting that the US could continue to act as global consumer of last resort, lifting worldwide growth levels.

Insight into the central bank’s 2020 reaction function was limited. The minutes said: “Participants regarded the current stance of monetary policy as likely to remain appropriate for a time”, with weak inflation and wider “uncertainties” helping to keep rates unchanged. At the time of the meeting, thirteen Committee members thought rates would stay on hold through 2020, while four expected to lift them a quarter-point.

After the decision, Jerome Powell told reporters that a “material reassessment” of economic conditions would be required to shift the central bank’s policy stance – but the minutes did not provide clarity on what this might mean in practice.

Instead, traders and investors zeroed in on a discussion surrounding the Fed’s balance sheet – which is decidedly not heading toward zero. In an attempt to counter repeated blowouts in interbank funding markets, the central bank began intervening in October, buying $60 billion a month in Treasury bills – while characterizing this as a “technical” fix in the plumbing of the financial system.

Markets, of course, have taken a different view, with many participants calling it “QE4” – equating it to a fourth round of quantitative easing, while seizing on this narrative to push asset prices skyward.

Policymakers discussed expanding purchases beyond Treasury bills and tweaking the interest rate paid on excess reserves. A standing repurchase facility was also “mentioned”, but details were scant.

Taken in sum, the minutes left liquidity assumptions intact and conveyed a relatively-dovish tone that is consistent with a number of recent speeches and interviews given by voting members – leaving the dollar largely unmoved.

More broadly, currency markets remain in flight-to-safety mode, with yesterday’s airstrike on the head of Iran’s elite Quds Force continuing to lift geopolitical risk premia. The assassination of Qassem Soleimani by US forces reawakened fears of a spiralling conflict in the Middle East, sending oil prices and safe-haven currencies soaring overnight – but historical experience suggests that currently-apocalyptic headlines are likely to give way to a more nuanced appreciation of the geopolitical calculus that has kept Iran and the United States in a war of attrition for decades. If so, these gains are likely to fade into the weekend, returning the focus to economic fundamentals and liquidity conditions early next week.

Have a great weekend!

Karl Schamotta
Chief Market Strategist

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