Watching The Dollar As Fed Minutes Loom

As we discussed on Tuesday, the FOMC appears to be dusting off the May playbook as the NY Fed’s Bill Dudley suggested that a September hike is indeed on the table after all.

Obviously that’s a pretty silly contention - they’d be out of their minds to hike before the election. Still, it was enough to spook markets and send yields higher:

Wednesday’s big event is the release of the July Fed Minutes which, as usual, will be carefully parsed for any hints of hawkishness. If we get anything like the April Minutes you might see a selloff into the close. You’ll of course want to watch the dollar as well.

Speaking of the dollar, Goldman is out Wednesday with an interesting (and amusing) note on the greenback’s “crosswinds,” which the bank says make the outlook “murky.” Here’s an excerpt which pretty much echoes what we said here on Tuesday:

“NY Fed President Dudley sent ripples through markets yesterday with his comment that the next rate hike is ‘getting closer.’ Tomorrow, Dudley is speaking in a recently scheduled press briefing, which is a strikingly similar set-up to when he used his press conference in May to endorse the hawkish message from the FOMC minutes. Judging from the tone of a number of other Fed speakers over the past couple of weeks, the message is likely to be that the September FOMC will be ‘live’ – as the Fed minutes today will probably show – and in any case that the Fed plans to raise rates again soon.”

Now first of all, for Dudley to say that the next rate hike is “getting closer” is a tautology unless of course they never plan to raise rates, which seems exceedingly possible. Second, it’s not clear why they do this. Have they not learned by now that less is more when it comes to talking about policy? Talk about it at the post-meeting presser and other than that just stick to broad discussions of esoteric econometric models that no one understands. That way, you don’t accidentally say the “wrong” thing. Citi has a different take:

“Every declarative sentence in the interview was on the dovish side (including the one’s highlighted above) or talking up the economy. The sentences that begin ‘at some point in time if everything I expect goes according to plan, it may be appropriate to begin discussion of a limited series of …’ contain the hawkish comments -- a pastiche but watch the interview. Even the September comment was ‘yeah, I think it’s possible’ and he goes on to discuss the economy.   Nowhere does he come close to saying concretely that he thinks a hike in 2016 is on or that he even expects one or that he wants one.”

In any event, Goldman moves on to discuss the recent run-up in USD LIBOR which has been a special obsession of ours over the past several weeks. As we’ve written extensively elsewhere, the move higher is largely attributable to upcoming money market reform that’s causing an exodus from prime funds which, starting in October, will be required to start reporting a floating net asset value. Obviously, USD LIBOR at seven-year highs raises questions about the implications for the dollar. Here’s Goldman’s take (from the same note excerpted above):

“For our Dollar view, the important take-away is that rising rates are not a market repricing of policy, nor are they indicative of a genuine funding crisis. Still, this raises the question of whether any increase in short-term rates is Dollar bullish regardless of the source. Here we would echo our US team’s finding that changes in very short-term interest rates, such as the TED spread, have a very limited effect on financial conditions (“LIBOR Increase Not Like a Rate Hike“, US Daily, August 8, 2016). It is only when they came as part of a genuine shift in policy or the outlook that those changes lead to large indirect effects on broader financial conditions. It is the signaling element that matters. As long as recent changes in the funding markets stay relatively contained, this will remain a sideshow for our Dollar view. We have bigger crosswinds to navigate.”

(Charts: Goldman)

Ok, fair enough, but we’re not 100% sure what “relatively contained” means in this context. If the price of unsecured funding rises sharply you’ve got problems. For commercial paper issuers and for entities like say, US branches of Japanese banks, the source of the “problem” isn’t the issue. The issue is a squeeze on short-term, unsecured dollar funding. You’re seeing the very same thing in cross-currency basis swaps:

So that’s a little context on the ongoing dollar funding crunch.

Next up, the Minutes. Stay tuned.

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