Brainard was certainly dovish but markets are not happy. Here is the bigger picture for the dollar according to BTMU:,
Here is their view, courtesy of eFXnews:
Our view that Fed Governor Brainard would provide hints of a shift in thinking toward a September rate increase proved incorrect and it is clear from her speech that she believes the current labour market/inflation trade-off dynamic suggests ample scope for remaining patient in regard to raising the federal funds rate. After the 2.5% drop in the S&P 500 on Friday, the index bounced 1.5% yesterday. The dollar move was a bit more reserved, falling 0.3% yesterday after gaining 0.3% on Friday. The modest FX moves perhaps reflect the fact that while Brainard’s comments now point to a greater chance of no action next week, the more important take-away from Fed rhetoric in recent weeks is that the FOMC is becoming increasingly divided and the chorus for reducing financial market instability risks through monetary action is getting louder.
If the FOMC goes next week, the likely timing of the next action would be March or even June next year. If the FOMC now doesn’t act, the divided Fed rhetoric still leaves us potentially with two rate hikes by mid-2017 – Dec and June. So the bigger picture is perhaps not hugely different for the dollar.
We have now entered the communication blackout period ahead of the meeting next week and hence there will be little to lift the now even lower probability priced in the market for a rate increase. We estimate the probability of a rate increase is now at just 18%. We would still argue that there is justification for the Fed to act next week and believe the FOMC is putting way too little weight on the potential positive message a Fed rate hike could bring – a perception of backing away again from a relatively small 0.25-point hike only fosters further the belief that the economy is in poor shape.
We noticed also that Governor Brainard expressed the importance of the dollar in FOMC decisions – this we were aware of, but we would argue that global conditions and the dollar are factors that now favour action. The Fed’s USD Major index is down close to 7% from the highs earlier this year and more importantly is weaker than the period ahead of the first rate increase in December last year highlighting the fact that it is the pace of rate increases that will be key for dollar direction and that moving every nine months is unlikely to drive the dollar notably stronger.
Still, we have to acknowledge now that a rate increase next week looks unlikely with the probability so low. While the dollar may be weaker over the very short-term, short-term nominal spreads remain at levels that will limit the scale of dollar selling, especially with more FOMC members suggesting limited additional time for delay.
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