Fed surprises markets, further USD weakness cannot be ruled out in medium/long term
(by Arnaud Masset)
Given the lacklustre pace of recovery of the US economy, most participants expected the Fed to stick to its initial plan: gradual rate tightening. Instead, the minutes of the March FOMC meeting revealed that the members discussed extensively the strategy to start unloading the $4.5 trillion of bonds and mortgage-backed securities that currently sit on its balance.
Technically, the Fed did not actually discuss selling those assets but rather changing the committee’s reinvestment policy later this year. Indeed, the central bank is currently reinvesting all principal payments from its Treasury, agency debt and agency MBS portfolios, which has the effect to maintain unchanged the nominal size of its portfolio.
Until now, Fed members were only vaguely discussing about unwinding its bonds portfolio. In addition, the balance sheet discussions only recently started to gain traction.
The market did not expect the Fed to move that fast as most analyst were expecting the Fed would start fine-tuning its reinvestment policy in the middle of 2018. This surprise move caught investors off guard and forced them to reassess the US economic outlook as well as the effect on the USD. Indeed, choosing to unload the balance sheet instead of tightening short-term rate has the advantage to limit, to some extent, USD appreciation.
On Wednesday, the Dollar erased completely its pre-FOMC minutes’ gains and ended the day flat against most of its peers. For now, the market is still digesting the minutes and its potential impact on the greenback. Investors are definitely cutting risk, pushing equities lower and the Japanese Yen higher.
Overall, the backdrop of political uncertainty in the European Union favours the USD in the short-term. However, the reflation trade in the US is, more than ever, being questioned by market participants as President Trump’s administration has been unable to carry out any of its planned reforms. Therefore, further USD weakness cannot be ruled out in the medium and long-term.
ECB minutes and Alexis Tsipras meets European Council President
(by Yann Quelenn)
Today’s investors will carefully watch the ECB minutes. Indeed, at their last meeting in March, it turned out that the European Central Bank was more hawkish than expected.
However, recent declarations from policymakers are cooling down this view and the minutes should bring the confirmation that the European institution should not move far away from the purchase of €60 billion of bonds until year-end.
We do not expect a strong market movement after the release. Markets are not pricing in a too strong narrowing of the divergence between the Fed and the EU.
Staying in Europe, Alexis Tsipras is going to meet European Council President Donald Tusk ahead of the Eurogroup, composed of Eurozone Finance Ministers, which will be held tomorrow (Friday). Tsipras hopes to renegotiate the bailout terms. We recall Greece is seeing its debt-to-GDP ratio exploding since the first bailouts and that massive growth is required to only reimburse the charge of the debt.