Fed minutes might show that moving ahead on the balance sheet will, for the time being, take some of the tension out of the Fed’s debate over inflation. That’s partly because hawks and doves appear to have different expectations for the impact on financial conditions of trimming the balance sheet. Everyone’s OK with moving on the balance sheet. The hawks think that will reduce the risk of inflation, while those worried that inflation is too low aren’t worried about the impact of the balance sheet.
Analysts expect the start of a gradual unwind of the balance sheet to be announced in September, with the next rate hike delayed until the final month of the year. The most likely market-moving discussion will be around inflation. The Fed’s preferred gauge of inflation slowed to 1.4 percent in June, well below the central bank’s 2 percent target.
Many officials, including Chair Janet Yellen, have pinned the weak inflation reports mostly on “transitory” and “idiosyncratic” price drops in specific sectors such as mobile phone services and pharmaceuticals. Yellen, however, conceded in testimony before Congress on July 12 that “there could be more going on.”
Fxstreet: The Federal Reserve left interest rates unchanged after its July 25-26 meeting and indicated it could begin shrinking its bond portfolio as soon as September. The minutes of the meeting will be released today at 18:00 GMT.
Key things to watch out for-
Is Fed still willing to look through weak inflation? The wait for pick up in US inflation continues. The official number for July released last week once again printed below estimate. The inflation expectations as represented by the 5-year, 5-year forward inflation expectation rate fell sharply during March – June period. The USD was offered across the board during the same time period. It clearly shows the outlook for the USD is primarily dependent on the inflation numbers. However, it is worth noting that the pick up the inflation expectations from the June low was ignored by the greenback till last week.
The US Dollar is finally catching up with rising inflation expectations this week. If the Fed minutes indicate that more Fed policymakers see the weak inflation as long-lasting, it could reduce the chances of an anticipated hike, thus the USD would drop. On the other hand, the corrective move in the USD would gather pace if the policymakers blame low inflation on transitory factors.
Debt limit: The Treasury Department has said the government has enough money to pay its bills on time through September. Meanwhile, the Fed is widely expected to start its balance sheet runoff program in September.
The Fed minutes due today would shed light on whether policymakers are worried about the debt showdown. Cautious comments could weigh over the USD and vice versa.
Balance Sheet Runoff: The July statement said the policymakers are in favor of reducing the Fed’s $4.5 trillion portfolio of bonds and other assets “relatively soon”. The markets believe ‘relatively soon’ means September. The minutes may provide a more definitive signal on the timing of the runoff. Hint at September could lead to a steeper Treasury yield curve and strong dollar.
Other key things that warrant attention are-
Gold – Rising channel intact
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