By Michael O’Neill
The Pied Piper of Hamelin is a legend dating back to the middle ages. It’s about a piper dressed in multicolored (pied) clothing who was hired by the villagers in Hamlin, Germany to rid the town of rats. The piper made his way through the town and lured the rats into the Weser River.
The modern-day version of this medieval tale played out in currency markets this week; this time with the Federal Open Market Committee (FOMC) as the Pied Piper and foreign exchange traders as the rats.
A EURUSD rally that had been in place since May 11, was broken the day before the FOMC minutes were released. After topping out at 1.1268, EURUSD declined to 1.1168 in anticipation of the minutes revealing a more hawkish bias to the Committee’s interest rate intentions than what was apparent in the May 3 FOMC policy statement. A similar trading pattern occurred in all G10 currency pairs.
FX traders determined that the minutes from the May 3 meeting were doveish and quickly sold the USD dollars that they had bought earlier.
The minutes revealed that at the beginning of May, “most, participants judged that if economic information came in about in line with their expectations, it would soon be appropriate for the Committee to take another step in removing some policy accommodation”. By any stretch of the imagination, that is a hawkish comment.
Yet, traders focused on the line “members generally judged that it would be prudent to await additional evidence indicating that the recent slowing in the pace of economic activity had been transitory before taking another step in removing accommodation”.
Arguably, the second line is why the Fed didn’t hike rates in May. If so, it is not a reason to believe these minutes are doveish.
At the beginning of April, the US dollar rallied when the March minutes showed the FOMC members talking about shrinking the balance sheet.
The minutes also revealed a “staff” created strategy to shrink the balance sheet. “Under the proposed approach, the Committee would announce a set of gradually increasing caps, or limits, on the dollar amounts of Treasury and agency securities that would be allowed to run off each month, and only the amounts of securities repayments that exceeded the caps would be reinvested each month. As the caps increased, reinvestments would decline, and the monthly reductions in the Federal Reserve’s securities holdings would become larger”, according to the minutes.
This was a more detailed balance sheet reduction proposal and “nearly all policymakers expressed a favorable view of this general approach”.
The suggestion of further rate hikes and balance sheet reduction are hawkish. Concluding otherwise and selling US dollars may prove to be an expensive miscalculation.
Stephen Poloz, the Pied Piper of the Bank of Canada has Canadian dollar traders moving like line dancers at a county fair.
“One step forward, two steps back Photo: Google Images
Traders decided that the tone of the May 24 Bank of Canada policy statement was “less neutral” than the tone of the April 12 statement. That’s because the final paragraph was much shorter and skipped the “uncertainties” rhetoric that closed the April statement.
The Canadian dollar rallied, but the BoC was only part of the equation. Soaring oil prices accounted for the lion’s share of the move.
West Texas Intermediate (WTI) has been on a tear since bottoming out at $43.75/barrel on May 4. The prospect that Opec would extend oil production cuts until March 2018 and steady declines in US crude inventories drove WTI to $51.97/b on May 24. The move got an added boost on speculation that the size of production cuts would increase. Saudi Arabia’s Oil Minister Khalid al-Falih disabused that notion when he reportedly said that the existing agreement would be extended on the existing terms.
Prices have since declined on profit taking but while prices are above $49.50/b, the intraday uptrend is intact. While oil prices remain above this level, USDCAD gains will be capped.
The Canadian dollar rally also raised doubts about the bullish USDCAD story that had supported prices since April. Some traders had visions of 1.400 in their eyes, due to a belief that the BoC was doveish, chatter about a housing bubble bursting, widening US and Canada interest rate differentials and lagging domestic economic performance.
Yet, the bearish USDCAD story is not all that compelling. The BoC will not be raising domestic rates until sometime in 2018 and the oil price rally may be capped below $55.00/barrel.
There is still a lot of USDCAD support between 1.3220 and 1.3340. The long term USDCAD uptrend from June 2016, remains intact above 1.3120.
The disruptive influence of President Trump and ongoing geopolitical issues have created an extra few layers of uncertainty into central bank deliberations.
The Pied Pipers of the FOMC and BoC are piping off-key tunes, simultaneously expressing optimism and caution, while leaving FX traders careening in an uneven circle of chaos.