The US Dollar Recovery Extends, has Fed Minutes to Thank for Latest Fillip

© Dmytro Synelnychenko, Adobe Stock

The Dollar has firmed thanks to expectations for higher US interest rates in 2018.

The Dollar remains in the driving seat on global foreign exchange markets at present with a short-term recovery continuing to place pressure on most other Dollar-based exchange rates.

The US currency received support overnight courtesy of the release of minutes from the January meeting of the US Federal Reserve's Open Markets Committee which gave markets a handle on where US interest rates are headed in 2018.

The minutes were clearly supportive of the Greenback: as European markets open, the Pound-to-Dollar exchange rate is quoted at 1.3883, having been as high as 1.4048 earlier in the week.

The Euro-to-Dollar exchange rate is quoted at 1.2266, having been as high as 1.2507 this week.

"USD was choppy around the release of Fed Minutes overnight. Initial decline was more than reversed as Minutes showed Fed officials are increasingly finding confidence in economic outlook," says Saktiandi Supaat, an analyst with Maybank in Singapore. "A number of officials saw the initial effects of the tax law as a sign that tax cuts will have a bigger growth effect than they previously thought. Taken together, this sparked off speculation that rates could rise at a faster pace this year."

One of the notable changes to the minutes released on Wednesday 22, was the addition of “further” to the sentence describing a gradual path of policy tightening.

This has signalled to markets that higher interest rates might be on the cards, which should typically prove supportive to the USD. Of course, 2018 has been a strange year for the Dollar as expectations for higher interest rates have not had the positive effect many have expected, nevertheless, the influence cannot be completely discounted and remain relevant.

"By itself, the significance of this change was unclear, since it did not change the meaning of the sentence. The minutes provided some clarification, in that they said, 'A majority of participants noted that a stronger outlook for economic growth raised the likelihood that further gradual policy firming would be appropriate,'" notes Lewis Alexander at Nomura in New York.

This highlights an increased “likelihood” of continued gradual policy firming and Alexander believes this likely reflects most participants’ view that a stronger near-term outlook has reduced the downside risk to their expected path of policy tightening.

Looking ahead, we have the Fed's Monetary Policy Report due for release on Friday, February 22 and then the semi-annual testimony by Federal Reserve Chair Powell next Wednesday.

Analyst Derek Halpenny at MUFG argues the latter is more important with regards to the Dollar's outlook; "a message in that testimony of maintaining the current pace of tightening would likely prove supportive for US and global equity markets and perhaps in that context the greater FX move may well be in the EM space with confidence in global growth getting a lift, EM and growth/commodity related FX should recover versus the US dollar. Safe-haven currencies would likely under-perform."

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