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Trading commentary

17 February 2010

FX Closing Note: More hawkish than expected FOMC

John J. Hardy, FX Consultant, Saxo Bank

FX Closing Note: More hawkish than expected FOMC

After yesterday's surprisingly dovish speech from the new Minneapolis Fed president Kocherlakota, who fretted employment conditions, the Fed developments today pushed bonds in the opposite direction. First, the FOMC meeting minutes today revealed that some officials were pushing for the unwinding of the Fed's balance sheet with asset sales "in the near future". This is somewhat in contrast with Bernanke's recent testimony to congress, in which he stated that asset sales were not expected in the near term. There was also discussion of widening the spread between the discount rate and the fed funds rate to 50 bps from its current 25 bps, as well as the idea that it would "soon" be time to move on the discount rate and to shorten the term of discount window loans to overnight.

In addition to these developments, we found out today the identity of at least one of those proponents for a trimming of the Fed's balance sheet (from the FOMC minutes), as the Fed's Plosser was out strongly indicating today that the Fed should sell its assets sooner rather than later and that careful choices and courage are needed to avoid inflation. He even complained about the "extended period" language in the Fed's official monetary policy statement. All of this added up to a rout in the bond market, which pulled the USD higher across the board and pushed the JPY back weaker. The jury is still out on the direction in bond markets, where the next big focus is next weeks' treasury auctions, which will include an auction of 30-year TIPS, and 2-, 5-, and 7-year notes.

Chart: EURUSD

A stark rejection of yesterday's rally raises the bar for the EURUSD bulls today. 1.3530 is the low for the cycle.