FX Update: USD bears beat a retreat after FOMC minutes

The USD was actually on the comeback trail well ahead of the FOMC minutes yesterday before the release of those minutes extended the rally further – with the day’s action suggesting that some portion of the last round of USD selling was perhaps a capitulation move, with stops going through as new levels traded. The takeaway from the FOMC minutes lacked drama, and the reaction mostly revealing how touchy the markets are to any shred of evidence that doesn’t support the “the Fed will offer maximum support at all times” narrative.

Most of the attention on the minutes were on the luke-warm interest in the yield curve control policy option and elsewhere, less urgency expressed on the need for the Fed to establish forward guidance for its policy rate trajectory. On the latter, the following quote:

With regard to the outlook for monetary policy beyond this meeting, a number of participants noted that providing greater clarity regarding the likely path of the target range for the federal funds rate would be appropriate at some point.

The “at some point” in the above portion of the minutes contrasts with the seeming urgency to provide guidance in the prior minutes “at upcoming meetings”. The implication is that perhaps the Fed is ready to sit on its hands a bit before pre-committing to a course of action. This makes some sense given the ups and downs of COVID-19 and its resurgence and the strength in some over-stimulated sectors of the economy relative to weakness elsewhere.

The yield-curve-control (YCC) discussion was rather non-committal at best, with “most” participants in the discussion argued that YCC or yield caps make no sense when yields all along the curve are so low. Others worried about the risk of an “excessive” growth in the balance sheet under such a policy, a code-phrase for the Fed entirely losing relevance and forced to balloon its balance sheet if appetite for treasuries is lost under an inflationary / negative real interest rate regime. Those in favour of the policy liked it from the angle of it allowing the Fed to actually purchase fewer assets.

The reaction was swift but not necessarily decisive. The minutes provide a modest hurdle for the narrative here, and their impact could fade quickly. On the other hand, the USD rally has set the technical situation on edge in most USD pairs, and new USD sellers need to come in quickly to erase this move or we risk biting back into the recent ranges and consolidating for a time. I have also been surprised that a more generally cautious tone in risk appetite hasn’t been struck ahead of the US election, as a Biden victory is the higher odds outcome. His platform promises a climate focus and reversal of some of Trump’s tax cuts. These policies  would mean higher costs of doing business both in terms of the cost of energy inputs for business operations, and of course tax costs that would require a re-rating of pricing models and multiples.

Chart: EURUSD
EURUSD reversed the price action that took the pair above the prior cycle highs, but hasn’t yet put in the tactical knock-out blow that arguably only arrives with a close below 1.1800.  The bigger trigger lower is the 1.1700 area lows of the recent multi-week consolidation, especially given very heavy long speculative positioning. The next two sessions critical for which way the price action is leaning.